Market Index

Uses of Security-Market Indexes

• As benchmarks to evaluate the performance of
professional money managers
• To create and monitor an index fund
• To measure market rates of return in economic
studies
• For predicting future market movements by
technicians
• As a substitute for the market portfolio of risky
assets when calculating the systematic risk of
an asset
 Market Indices
• A 'world' or 'global' stock market index — such as the MSCI World
or the S&P Global 100 — includes stocks from multiple regions.
Regions may be defined geographically (e.g., Europe, Asia) or by
levels of industrialization or income (e.g., Developed Markets,
Frontier Markets).
• A 'national' index represents the performance of the stock market of a
given nation—and by proxy, reflects investor sentiment on the state
of its economy. The most regularly quoted market indices are national
indices composed of the stocks of large companies listed on a nation's
largest stock exchanges, such as the American S&P 500, the Japanese
Nikkei 225, and the British FTSE 100.
• Other indices may be regional, such as the FTSE Developed Europe
Index or the FTSE Developed Asia Pacific Index. Indexes may be
based on exchange, such as the NASDAQ-100 or NYSE US 100, or
groups of exchanges, such as the Euronext 100 or OMX Nordic 40.
 Market Indices
• The Wilshire 5000 Index, the original total market index, represents
the stocks of nearly every publicly traded company in the United
States, including all U.S. stocks traded on the New York Stock
Exchange (but not ADRs or limited partnerships), NASDAQ and
American Stock Exchange. Russell Investment Group added to the
family of indices by launching the Russel Global Index.
• More specialized indices exist tracking the performance of specific
sectors of the market. Some examples include the Wilshire US REIT
which tracks more than 80 American real estate investment trusts and
the Morgan Stanley Biotech Index which consists of 36 American
firms in the biotechnology industry.
• Other indices may track companies of a certain size, a certain type of
management, or even more specialized criteria — one index
published by Linux Weekly News tracks stocks of companies that sell
products and services based on the Linux operating environment.
 Differentiating Factors in
Constructing Market Indexes
Computational procedure
• arithmetic average
• compute an index and have all changes,
whether in price or value, reported in
terms of the basic index
• geometric average
 Stock-Market Indicator Series
Price Weighted Series
• Dow Jones Industrial Average (DJIA)
• Nikkei-Dow Jones Average
Value-Weighted Series
• NYSE Composite
• S&P 500 Index and more…
Unweighted Price Indicator Series
• Value Line Averages
• Financial Times Ordinary Share Index
 How The Index Components Are Weighted
• In a price-weighted index such as the Dow Jones Industrial Average, NYSE
Arca Major Market Index, and the NYSE ARCA Tech 100 Index, the price of
each component stock is the only consideration when determining the value
of the index. Thus, price movement of even a single security will heavily
influence the value of the index even though the dollar shift is less significant
in a relatively highly valued issue, and moreover ignoring the relative size of
the company as a whole.
• In contrast, a capitalization-weighted (also called market-value-weighted)
index such as the S&P 500 or Hang Seng Index factors in the size of the
company. Thus, a relatively small shift in the price of a large company will
heavily influence the value of the index.
• An equal-weighted index is one in which all components are assigned the
same value.For example, the Barron's 400 Index assigns an equal value of
0.25% to each of the 400 stocks included in the index, which together add up
to the 100% whole.
 How The Index Components Are Weighted
• A modified capitalization-weighted index is a hybrid between capitalization
weighting and equal weighting. It is similar to a capitalization weighting with
one main difference: the largest stocks are capped to a percent of the weight
of the total stock index and the excess weight will be redistributed equally
amongst the stocks under that cap.
• Moreover, in 2005, Standard & Poor's introduced the S&P Pure Growth Style
Index and S&P Pure Value Style Index which was attribute-weighted. That
is, a stock's weight in the index is decided by the score it gets relative to the
value attributes that define the criteria of a specific index, the same measure
used to select the stocks in the first place. For these two indexes, a score is
calculated for every stock, be it their growth score or the value score (a stock
cannot be both) and accordingly they are weighted for the index
 Dow Jones Industrial Average
(DJIA)
• Best-known, oldest, most popular series
• Price-weighted average of thirty large well-
known industrial stocks, leaders in their
industry, and listed on NYSE
• Total the current price of the 30 stocks and
divide by a divisor (adjusted for stock splits
and changes in the sample)
 Dow Jones Industrial Average
(DJIA)
• To calculate the DJIA, the sum of the prices of all 30 stocks is
divided by a divisor, the Dow Divisor. The divisor is adjusted in case
of stock splits, spinoffs or similar structural changes, to ensure that
such events do not in themselves alter the numerical value of the
DJIA.

• where p are the prices of the component stocks and d is the Dow
Divisor.
• The Dow Divisor was 0.14748071991788 on June 26, 2018.
Presently, every $1 change in price in a particular stock within the
average equates to a 6.781 (or 1 ÷ 0.14748071991788) point
movement.
 Morgan Stanley Capital
International (MSCI) Indexes
• Three international, nineteen national, and
thirty-eight international industry indexes
• MSCI World Index include 1,649 companies
listed on stock exchanges in 23 countries with
a combined capitalization representing
approximately 60 percent of the aggregate
market value of the stock exchanges of these
countries
 Morgan Stanley Capital
International (MSCI) Indexes
• All the indexes are market-value weighted
• Reporting is in U.S. dollars and the country’s
local currency
• Also provides
– price to book value (P/BV) ratio
– price to cash earnings (earnings plus depreciation)
(P/CE) ratio
– price to earnings (P/E) ratio
– dividend yield (YLD)
 Bond-Market Indicator Series
• Relatively new and not widely published
• Growth in fixed-income mutual funds
increase need for reliable benchmarks for
evaluating performance
• Many managers have not matched
aggregate bond market return
– increasing interest in bond index funds
– requires an index to emulate
Difficulties in Creating and Computing
Bond-Market Indicator Series
• Universe of bonds is much broader than that of stocks
• Range of bond quality varies from U.S. Treasury
securities to bonds in default
• Bond market changes constantly with new issues,
maturities, calls, and sinking funds
• Bond prices are affected by duration, which is
dependent on maturity, coupon, and market yield
• Correctly pricing individual bond issues without
current and continuous transaction prices available
poses significant problems
Investment-Grade Bond Indexes
• Four investment firms maintain indexes for
Treasury bonds and other investment grade
(rated BBB or higher) bonds
• Relationship among these bonds is strong
(correlations average 0.95)
• Returns for all these bonds are driven by
aggregate interest rates - shifts in the
government yield curve