Practice investment management pim3 ch13

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 underl

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MARKET INDEXES

CHAPTER THIRTEEN

Practical Investment Management

Robert A Strong

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 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

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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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Table 13-4 DO THIS IN TWO SLIDES

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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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Insert Figure 13-1 here.

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 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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Insert Figure 13-2 here.

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 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 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