CHAPTER THIRTEEN

MARKET INDEXES

Practical Investment Management

Robert A. Strong
 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

Insert Table 13-2 here.

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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

Insert Table 13-3 here.

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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

Dow Jones Averages

 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.

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 Popular Indexes: Stock Indexes

Insert Figure 13-1 here.

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 Popular Indexes: Stock Indexes

Insert Table 13-7 here.

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 Popular Indexes: Stock Indexes

Standard & Poor’s 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.

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 Popular Indexes: Stock Indexes

Insert Figure 13-2 here.

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 Popular Indexes: Stock Indexes

Others
 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.

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 Popular Indexes: Fixed Income Indexes

 More than 400 indexes measure fixed income

securities.
 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

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