MARKET INDEXES

CHAPTER THIRTEEN

Practical Investment Management

Robert A. Strong

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Outline

Introduction Index Construction

Price Weighting Equal Weighting Capitalization Weighting

Popular Indexes Stock Indexes Fixed Income Indexes International Indexes

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Introduction

Indexes are indicators of the day’s market activity.

They help us interpret investment results and provide a benchmark for performance measurement.

They are also useful in financial research when an investigator seeks to discover the relationship between certain economic variables and market results.

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Index Construction: Price Weighting

A price-weighted index is composed of a single share of each of the index components, regardless of the price of the share or the size of the underlying company.

For example, the shares of 30 industrial companies make up the Dow Jones Industrial Average (DJIA).

To account for artificial price changes due to stock splits, an index divisor is made use of.

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Index Construction: Price Weighting

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Index Construction: Equal Weighting

An equal-weighted index reflects the performance associated with the selection of a particular security by chance. It is measured by price change rather than by price alone.

Theoretically, equal weighting is preferable to price weighting.

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Index Construction: Equal Weighting

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Index Construction: Capitalization Weighting

In capitalization weighting, also called value weighting, the share price is multiplied by the number of outstanding shares.

The total is then compared to some arbitrary starting value (base value).

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Index Construction: Capitalization Weighting

Table 13-4 DO THIS IN TWO SLIDES

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Index Construction: Capitalization Weighting

Table 13-4 DO THIS IN TWO SLIDES

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Popular Indexes: Stock Indexes

The four primary averages are the industrial average (30 large blue chip companies), the transportation average (20 transportation companies), the utilities average (15 public utility stocks), and the Dow Jones composite (all the 65 stocks in the DJIA, DJTA, and DJUA).

Price-weighted.

Dow Jones Averages

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Popular Indexes: Stock Indexes

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Popular Indexes: Stock Indexes

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Popular Indexes: Stock Indexes

The main indexes are the S&P 500 Composite (500 NYSE-traded securities), S&P Mid Cap 400 (400 mid-capitalization securities), S&P Small Cap 600 (600 small-cap stocks), and the S&P Super Composite 1500 (500 + 400 + 600).

Value-weighted. Note that a divisor is still necessary because of

firm replacements, issuance of additional shares, and share repurchases.

Standard & Poor’s Indexes

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Popular Indexes: Stock Indexes

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Popular Indexes: Stock Indexes

The NYSE Composite is an average of all the stocks listed on the New York Stock Exchange.

The Russell 3000 index is a mixture of both large- and small-capitalization stocks and, to many portfolio managers, a better representation of the broad market.

Others

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Popular Indexes: Fixed Income Indexes

More than 400 indexes measure fixed incomesecurities.

Examples include :

- Dow Jones 20 Bond Index- S&P Municipal Bond Index- S&P U.S. Government Bond Index- Salomon Smith Barney Corporate Bond Index

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Popular Indexes: International Indexes

European indexes- United Kingdom: FT-SE 100- Germany: DAX 30- France: CAC-40- Italy: MIB 30

Asia and the Pacific Rim

- Japan: Nikkei 225, TOPIX, Nikkei 300- Australia: All Ordinaries- Hong Kong: Hang Seng

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Review

Index Construction Price Weighting Equal Weighting Capitalization Weighting

Popular Indexes Stock Indexes Fixed Income Indexes International Indexes