"Index Portfolio Strategy Construction Techniques: I. Full Replication or Full Sampling: All securities in the index are purchased in proportion to their weights in the index. • Advantages: All the securities in the index are purchased in proportion to their weights in the index, It helps to ensure close tracking • Disadvantages: More transaction cost, High commission for reinvestment in dividend II. Sampling: Only a representative sample of the stocks that make up the index are purchased. • Advantages: Buys a representative sample of stocks in the benchmark index according to their weights in the index, Lower commission, Reinvestment of dividends is less difficult • Disadvantages: More tracking error III. Quadratic Optimization or Programming • Advantages: Historical Information on price changes and correlation between securities are input into a computer that determines the composition of a portfolio that will minimize tracking error with the benchmark. • Disadvantages: Based on historical data which will lead to failure to track the index Choosing the Right Index Involves following considerations: • Small market indexes are liquid but under diversified • Larger market indexes are illiquid but diversified • So the benchmark index should be the right mix of both • Good Index characters are: Representative of market, Well diversified,Highly liquid, Professionally managed. Source: http://in.docsity.com/en-docs/Equity_Portfolio_Management_Strategies_-_Security_Analysis_and_Portfolio_Management_-_Solved_Quiz_"
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