A study on sector index of stock market proposal for development of FPTS sector index

However, the securities market of Vietnam still lacks of ancomprehensive and effective sector indices tools since the official marketindices of the securities market of Vietnam VN-Index

Nguyen Minh Khoi

A STUDY ON SECTOR INDEX OF STOCK MARKET PROPOSAL FOR DEVELOPMENT OF FPTS

SECTOR INDEX

master of business administration thesis

Hanoi - 2008

Nguyen Minh Khoi

A STUDY ON SECTOR INDEX OF STOCK MARKET PROPOSAL FOR DEVELOPMENT OF FPTS

TÓM TẮT ii

ACKNOWLEDGEMENTS iii

TABLE OF CONTENTS iv

List of figures viii

List of tables viii

List of equations ix

INTRODUCTION 1

1.1 Research problem 1

1.2 Objectives &Aims 1

1.2.1 Objectives 1

1.2.2 Aims 1

1.3 Research question: 2

1.4 Method/Approaches 2

1.5 Scope of work 2

1.6 Data resources 2

1.7 Method 3

1.8 Significance 3

1.9 Limitations 3

1.10 Expected result: 3

1.11 Follow – up (potential) 4

1.12 Short introductions 4

1.12.1 Chapter 1: Theory foundation 4

1.12.2 Chapter 2: Analysis of sector indices 4

1.12.3 Chapter 3: proposal for developing FPTS sector index 5

Chapter 1: THEORY FOUNDATION 6

1.1 Introduction 6

1.1.1 Definition of market index and sector index 6

1.1.2 Type of market indices 6

1.1.2.1 By industry (Sector indices) 7

1.1.2.2 By geographic location 7

1.1.2.3 By the nature of index members 7

1.1.2.4 By market capitalization (size) 8

1.2 Sector index applications 8

1.2.1 Sector monitoring and determining sector trend 8

1.2.2 Creation of index-linked investment products 9

1.2.3 Precise asset allocations 9

1.2.4 Hedge economic risk 9

1.2.5 Sector investing 10

1.2.5.1 Increase returns and reduce the overall risk of a diversified portfolio 10 1.2.5.2 Take advantage of long-term trends 10

1.3 Sector indices calculation 11

1.3.1 Step 1: Calculation methods 11

1.3.1.1 Passcher method 11

1.3.1.2 Laspeyres method 12

1.3.1.3 Fisher method 12

1.3.1.4 Simple arithmetic price average 13

1.3.1.5 Simple geometric price average method 13

1.3.1.6 Comparison of index calculation method 14

1.3.2 Step 2: Members selection 14

1.3.3 Step 3: Divisor adjustment 15

1.3.3.1 Reasons for divisor adjustment 15

1.3.3.2 Divisor adjustment formula 16

1.3.3.3 Timing of divisor adjustments 17

1.3.4 Step 4: Index calculation 18

Chapter 2: ANALYSIS OF SECTOR INDICES 19

2.1 Analysis of international sector indices 19

2.1.1 S&P select industry indices 19

2.1.1.1 Index Description 19

2.1.1.2 Sector classification system 19

2.1.1.3 Index membership 19

2.1.1.4 Index calculation 21

2.1.2 Dow Jones U.S Industry Indices 22

2.1.2.1 Index description 22

2.1.2.2 Sector classification system 22

2.1.2.3 Index membership 23

2.1.3.2 Sector classification system 24

2.1.3.3 Index membership 24

2.1.3.4 Index calculation 25

2.1.4 MorningStar sector Indices 26

2.1.4.1 Index description 26

2.1.4.2 Sector classification system 26

2.1.4.3 Index membership 27

2.1.4.4 Index calculation 28

2.1.5 NYSE Sector Indices 29

2.1.5.1 Index description and sector classification system 29

2.1.5.2 Index membership 30

2.1.5.3 Index calculation 31

2.1.6 Comparison and conclusion of international sector indices 32

2.1.6.1 Comparison 32

2.1.6.2 Conclusion 33

2.2 Analysis of local sector indices 34

2.2.1 VN – Index and HASTC Index 34

2.2.1.1 Index description 34

2.2.1.2 Index membership and calculation 35

2.2.2 CBV Index 37

2.2.2.1 Index description 37

2.2.2.2 Index Membership 40

2.2.2.3 Index calculation 42

2.2.3 DC 30 Index 43

2.2.3.1 Index introduction 43

2.2.3.2 Index membership and calculation 44

2.2.4 Thang Long 20, 30 Index 46

2.2.4.1 Index description 46

2.2.4.2 Index Membership .46

2.2.4.3 Index calculation 47

2.2.5 SSI 30 Index 48

2.2.5.1 Index description 48

2.2.5.2 Index membership and calculation 49

2.2.7.2 Additional drawbacks of other local index 54

Chapter 3: PROPOSAL FOR DEVELOPING FPTS SECTOR INDEX 55

3.1 Introduction and Objectives 55

3.2 Methodology 55

3.2.1 Sector classification system 55

3.2.2 Base value and base date 56

3.2.3 Weighting scheme 56

3.2.4 Index formula 56

3.2.5 Data sources 57

3.3 Index memberships 58

3.3.1 Index eligibilities 58

3.3.2 Additions to and deletions from FPTS sector indices 59

3.3.2.1 Additions to FPTS sector indices 59

3.3.2.2 Deletions from FPTS sector indices 60

3.3.3 Member selection flowchart 61

3.4 User requirement description (URD) 62

3.4.1 Back-end user requirements 62

3.4.2 Front –end user interface and functionalities 62

3.4.2.1 Page layout and elements 63

3.4.2.2 Prototype of FPTS sector index homepage 64

3.4.2.3 Prototype of FPTS sector index sectorpage 65

3.4.2.4 Prototype of FPTS sector member page 66

CONCLUSION 67

REFERENCES 68

Figure 2.1: Summary of Morningstar sector index family 27

Figure 2.2: CBV Index family 37

Figure 2.3: CBV Sector Index family 39

Figure 2.4: DC VN30 Domestic performance vs VNINDEX 44

Figure 2.5: DC VN30 Foreign performance again 44

Figure 2.6: SSI 30 performance in 2007 49

Figure 3.1: Procedure to select stocks to FPTS sector index 61

Figure 3.2: Page layout of FPTS sector indices pages 63

Figure 3.3: Prototype of FPTS sector index homepage 64

Figure 3.4: Prototype of FPTS sector index sector page 65

Figure 3.5: Prototype of FPTS sector member page 66

List of tables Table 1.1: Divisor adjustment formula table 16

Table 2.1: Comparison of international sector indices 32

Table 2.2: Top 10 companies in DC VN30 45

Table 2.3: Thanglong Index scoring table 47

Table 2.4: Local indices comparison 50

Table 3.1: Major element and content of FPTS sector indices 63

Equation 1.2: Laspeyres method formula 12

Equation 1.3: Fisher method formula 13

Equation 1.4: Simple arithmetic price average formula 13

Equation 1.5: Simple geometric price average formula 13

Equation 1.6: Index calculation formula 18

1.1 Research problem

One of the most widely used tools to track industry or sectorperformance in the securities market is sector indices These are the essentialtools for investors to follow up sector movements as well as to see the trend inthose movements However, the securities market of Vietnam still lacks of ancomprehensive and effective sector indices tools since the official marketindices of the securities market of Vietnam (VN-Index and HASTC-Index) are

to measure the overall market performance rather than any particular sector.This thesis ―A study on sector index of stock market and proposal fordevelopment of FPTS sector index‖ is aimed at give out a detailed proposalfor the development of FPTS sector indices

1.2 Objectives &Aims

1.2.1 Objectives

Study sector index definitions

Study sector index application and calculation methodology

Compare and analyze most known international and local sector indices

1.2.2 Aims

Give out detailed proposals for the development of FPTS sector index family

1.3 Research question:

In order to achieve the objectives of the thesis, the author of thesis will try to answer the following questions:

What are definition, types and applications of sector indices?

What are the calculation methods of sector indices?

What are the most known international and local sector indices? Whatare the differences and similarities among them?

How to select members of FPTS sector indices?

How to calculate FPTS sector indices?

What are the core FPTS sector back-end functionalities and frond-endinterfaces (user requirement description)?

1.4 Method/Approaches

Empirical method

Approaches: statistics

1.5 Scope of work

This thesis study most widely mentioned sector indices (both

international and local) by the time of finishing this thesis (August, 2008)

White paper, published methodology and other available documents

on websites of international and domestic indices

Other resources: Internet forum, Google searches…

On the practice, it gives a detailed proposal to develop FPTS sectorindices for FPT Securities Company including both methodology, back-endand front-end design and functions This is a good example and reference forany new sector indices

1.10 Expected result:

The study expects to show the following findings:

Bring systematic knowledge about indices and sector indices

Provide a deep analysis of popular international and local sector indices

Develop a detailed proposal of FPTS sector indices for FPT SecuritiesCompany This proposal can also be considered as a specimen for othernew sector indices

1.11 Follow – up (potential)

Further study can also be carried out to fine-tune the backend functionsand front-end user interface and functions after the official launch of FPTSsector indices and receiving the feedbacks from FPTS clients

1.12 Short introductions

Due to the standardized thesis format and for the sake of clarity, afterthe introduction to its topic, this thesis is divided into three chapters asfollows:

1.12.1 Chapter 1: Theory foundation

This chapter presents to the reader what other authors have written onthe chosen subjects, which cover mainly definition, types, applications andcalculation of sector indices The chapter seeks to give the topic depth andperspective, and further establish a basis on which the analysis is built

1.12.2 Chapter 2: Analysis of sector indices

This chapter analyzes the most 5 international and local well-known sector indices in term of index description, membership requirements, sector classification and calculations A detailed comparison of the two groups are also presented

1.12.3 Chapter 3: proposal for developing FPTS sector index

This chapter, after listing the objectives of developing FPTS sector indices, presents detailed proposal for FPTS sector indices methodology, membership requirements and user requirement description for FPTS sector indices.

Chapter 1: THEORY FOUNDATION

1.1 Introduction

1.1.1 Definition of market index and sector index

According to Wikipedia: ―In economics and finance, an index is asingle number calculated from a set of prices or of quantities Examples are aprice index, a quantity index (such as real GDP), a market performance Index(such as a labor market index / job index or a stock market index) Values ofthe index in successive periods (days, years, etc.) summarize level of theactivity over time or across economic units (regions, countries, etc.)‖

According to Standard and Poor’s: ―An index is a single descriptivestatistic that summarizes the relative change in an underlying group ofvariables‖ In case of a securities market index, that underlying variables areprices of securities available in the market including stock, bond, derivatives

(Important note: in the context of this thesis, the term “market index” is also

referred to as “securities market index” and can be used exchangeably) A

market index is designed to measure price changes of an overall securities

market A sector index is a market index which is designed to measure theperformance of a distinct industry sector

1.1.2 Type of market indices

Over time, many indices have been created, maintained and improved

by financial institutions in the world Indices can be classified by manycharacteristics of indices These characteristics groups indices into groups forthe purpose of classification These characteristics include but not limited to:

1 Sector or industry of index members

2 Geographic location: where the members of indices resides

3 The nature of index members: whether they are equity, bond or commodity

4 Market capitalization or size of index members

5 Style (value or growth) of index members

6 Dividend payout ratio of its stock members

1.1.2.1 By industry (Sector indices)

When in an index includes all (or representatives) stocks of an industry

or sector, that index is a sector index and measures the performance of itsindustry sector

1.1.2.3 By the nature of index members

1 Equity index: track the performance of equity securities.

2 Bond indices: track the performance of bond markets (by broad

market, by sectors and term structure).

3 Commodity indices: include indices that employ different

strategic combinations of commodity futures.

1.1.2.4 By market capitalization (size)

Stock groups are categorized by their market capitalization Theseinclude large cap, mid cap and small cap indices

1.1.2.5 By style (value or growth)

The style of an index is the style of its stock members which are oftenbased on price to book ratio Price to book ratio of a stock is its share pricedivided by its common equity

1.1.2.6 By dividend (dividend indices)

Dividend indices contain all dividend-paying stocks that pay dividendsconsistently and sustainably or dividend leaders’ indices that include thehighest yielding

1.1.2.7 By combination of the above characteristics.

An index can have combination of the above-said characteristics Forexample: the combination of composite style indices and capitalizationindices such as large-value indices and small-growth indices

1.2 Sector index applications

Sector indices have become vital investment tools for professionalinvestors Main applications of sector indices include:

1.2.1 Sector monitoring and determining sector trend

Using sector index values, investors can quickly grasp sectorperformance and shifting patterns A sector index acts as a proxy for theaggregate price changes of all of the stocks which make up that sector and, as

a result, measures the price direction or volatility of the particular sector

Sector indices are updated frequently throughout each trading day so thattrends in market price movements can be quickly seen, thereby enablingtrading decisions (i.e buy, sell or hold at any particular time) to be madeexpeditiously

1.2.2 Creation of index-linked investment products

Data and insights from a particular sector are inputs to support thecreation of index-linked investment products such as mutual funds andderivatives etc

1.2.3 Precise asset allocations

Because there are distinct indices for each investment style, investorscould determine the corresponding portfolio risks and make precise assetallocations accordingly

1.2.4 Hedge economic risk

Just like stocks, each sector has its own characteristics For example,certain sectors can be characterized as defensive or cyclical in nature.Defensive sectors are less affected by recessions and economic adversity Theutilities sector (gas, electricity) is considered defensive as demand for thissector is stable and independent of the state of the economy Conversely,cyclical sectors (for example the consumer discretionary sector whichincludes goods like automobiles and refrigerators etc) generate high profits in

a prosperous economy but low profits as the economy degrades Besides,certain sectors are more interest-rate sensitive than others (such as financialservices, banking, real estate and construction)

Therefore, recognizing these sector characteristics enables investors tohandpick sectors and combine them in the most efficient way in theirportfolios to achieve their investment goals.

1.2.5 Sector investing

Sector indices are attached great importance and widely used to supportsector investing Sector investing is a relatively popular investment strategy.This strategy is most appropriate for those who have a diversified portfolio, along-term investment outlook and are comfortable with the risks associatedwith equity investing Sector investing could bring the following benefits:

1.2.5.1 Increase returns and reduce the overall risk of a diversified portfolio

Research has shown that adding a sector investing strategy in adiversified portfolio may not only increase returns but also reduce overall risk

of the portfolio, since some sectors such as energy, utilities and real estate etc.have low-to-moderate correlations with the overall market

1.2.5.2 Take advantage of long-term trends

With sector investing strategy, investors could make huge profits if theycorrectly anticipate long-term trends of the sector For example, if investorscorrectly forecast that there would be a large aging population of babyboomers in the United Kingdom, the United States, Canada and Australia afterthe post- world war II baby boom, they could benefit from investing in thehealthcare sector because there would be an increased need for healthcareproducts and services by baby boomers in the future

1.3 Sector indices calculation

The calculation of sector indices comprises of four steps

Figure 1.1: Steps to calculate indices includes 4 major steps

1.3.1 Step 1: Calculation methods

Currently, there are 5 popular sector index calculation methods:

1.3.1.1 Passcher method

This is a weighted average index in which the weighting factor is thenumber of share outstanding in the period of calculation Passcher is the mostpopular method and also referred to as market capitalization weighted index

Equation 1.1: Passcher method formula

In which: Ip: Passcher market price index

Pt: Price at the time of t (reporting period)

P0: Price at the base time (t =0)

Qt: Quantity (weighting factor) at the time of calculation (t)

The indices KOSPI (Korea); S&P500(USA); FT-SE 100 (Britain) ;TOPIX (Japan) ; CAC (France); TSE (Taiwan); Hangseng (Hong Kong);

Swish indices,… and Vn-Index and HASTC-Index of Vietnam apply this method.

1.3.1.2 Laspeyres method

This is a weighted average index with the weighting factor is the number

of share outstanding in the period of calculation

Laspeyres price average index is a weighted average index in which theweighting factor is the number of share outstanding in the base period.Consequently, the calculation result depends on the proportion of outstandingshares in the base period

Equation 1.2: Laspeyres method formula

In which: IL: Laspeyres average price index

Pt: price at time of t (reporting period)

P0: price at the base period (t =0)

Q0: Quantity or the outstanding shares (weighting factor) at the baseperiod (t=0)

There are few countries applying this Laspeyres method includingGerman FAZ and DAX

1.3.1.3 Fisher method

Fisher average price index is the geometric mean between Passcheraverage price index and Laspeyres average price index This methodovercomes the weaknesses of the two above methods since its result dependsboth on the weighting factors at both base period and calculation period

Equation 1.3: Fisher method formula

In which: I f: Fisher average price index

I p: Passcher average price index

I l: Laspeyres average price index

In theory, this method is available, but in fact, no country has applied this method

1.3.1.4 Simple arithmetic price average

Beside the above methods, the simple arithmetic average price index isalso popular The formula is simple: the total sum of stock price is divided by thenumber of stocks included

Equation 1.4: Simple arithmetic price average formula

In which: Ip: simple arithmetic price average

Pi: price of stock in: number of stock included in the indexThe Dow Jone index family of the USA, Nikkei 255 of Japan, and MBI ofItalia apply this method This method is appropriate when the price of stockslisted is relatively near one another or in other word; their standard deviation ()

is low

1.3.1.5 Simple geometric price average method

Equation 1.5: Simple geometric price average formula

In which: Ip: simple geometric price average

Pi: price of stock in: number of stock included in the index

This method is only advisable when the standard deviation of the stocksincluded is relatively high The indices Value line (USA); FT-30 (Britain)apply this method

1.3.1.6 Comparison of index calculation method

It is very hard to say which index calculation method is better thanother method in general The choice of calculation method depends on thepurpose of each index, the popularity of each method and is subject to thedecision of the index developers However, Passcher method or marketcapitalization weighted method is becoming increasingly popular nowadayssince it reflects the ―relative importance‖ of one stock via its marketcapitalization as the weighting factor

1.3.2 Step 2: Members selection

The second important step in building average price index is theselection of index members The New York stock exchange includes morethan 3000 stocks while Dow Jone composite comprises of only 65 stocks inwhich Dow Jones Industrial Average (DJIA) has only 30, Dow JonesTransportation Average (ADTA) only 20 and Dow Jones Utilities Average(AJUA) only 15 Although, including only a small number of member stocks,the Dow Jones index family still lasts for long because it reflects trend,development of the overall price movement The index members are

representative for the population since the non-representative members ofindices are replaced by more representative ones For example, in November,

1999, four members of DJIA were replaced

As for Vietnam or any emerging market, since the number of stocklisted has not been large, the market index should include all listed stocks.However, the trading quantity and volume should also be taken into account

If one stock has no trading or every limited quantity for a long time, it should

be expelled from the index The purpose of that action is to make sure that theindex can reflect the fair movement of the market prices

1.3.3 Step 3: Divisor adjustment

1.3.3.1 Reasons for divisor adjustment

During the continuous calculation of a sector index, some factors thatchange the quantity and value of stocks will affect the continuity of the index.The factors include inclusion, exclusion of index members, replacement ofindex members, stock split or merger, stock dividend, cash dividend,additional issuance, stock warrant, stock price adjustment on ex-rightdate….To negate for distortions caused by those factors so that the averageprice index only reflects the changes in stock price, the index divisoradjustment is needed

The following formula will be used for divisor adjustments due to

corporate action (Note: No divisor adjustments are necessary for stock splits,

since market capitalization does not change and the share number and shareprice are adjusted prior to the opening of trading on the split’s ex-date)

1.3.3.2 Divisor adjustment formula

Whenever a corporation implements an action that affects its stocks(such as dividend payment, stock split or rights offering etc.), the divisorneeds to be adjusted upwards, downwards or remain the same Assumingstockholders receive ―B‖ new stocks for every ―A‖ stocks they own in thefollowing corporate actions:

Table 1.1: Divisor adjustment formula table

(similar to stock split or bonus issue)

additional shares at discount prices to existing

No Corporate action

stock dividend and rights offering

Source: FPT Securities Companies, Analysis Department, 2008

1.3.3.3 Timing of divisor adjustments

1 For rights offering and stock dividend

On the ex-right date, the share price, number of outstanding sharesand divisor will be adjusted based on information about rights exercise,share price and outstanding shares of the last trading session Thenumber of outstanding shares is adjusted upwards by the provisionalformula-based number of additional shares

On the effective listing date of additional shares, the number ofoutstanding shares is adjusted again (if there is any difference betweenthe provisional number of additional shares and the actual number ofadditional shares issued) 1 according to data provided by HOSE andHASTC

2 For the purchase and sale of treasury stocks

The adjustment date is the date when the corporation announces thepurchase or sale of treasury stocks is completed in accordance with theregistered trading time In case the registered volume of treasury stocks to bebought/sold is not fully bought/sold on the last day of registered trading timeand the corporation registers to buy/sell the rest, we continue to adjust the

1 In reality, the effective listing date of additional shares occurs after the ex-right date.

number of outstanding shares on the last day of this supplementary trading time pursuant to the corporation’s announcement.

1.3.4 Step 4: Index calculation

Equation 1.6: Index calculation formula

In which

It: Index value of day t

Dt: divisor of the day t A divisor is used to re-base the index to start theindex at the base value

MVt: the total market value of the day t

The value of Qt depends on the weighing scheme of each weighting method See Step 1: Calculation methods on page 11 above

Chapter 2: ANALYSIS OF SECTOR INDICES

2.1 Analysis of international sector indices

2.1.1 S&P select industry indices

2.1.1.1 Index Description

The S&P Select Industry Indices are designed to measure theperformance of narrow Global Industry Classification Standard (GICS) sub-industries or groups of sub-industries S&P industry indices have base value

of 1000 on December 15, 2000

2.1.1.2 Sector classification system

The GICS structure consists of 10 sectors, 24 industry groups, 67industries and 147 sub- industries Companies are classified primarily based

on revenues; however, earnings and market perception are also considered inclassification analysis The GICS sub-industry level offers the most granularlevel of industry definition Therefore, the S&P Select Industry Indices offerthe purest representation of a particular industry

2.1.1.3 Index membership

Membership is based on a company’s GICS classification, as well asliquidity and market cap requirements To be eligible for an S&P SelectIndustry Index, companies must rank in the top 90% of their relevant GICSsub-industry by float- adjusted market capitalization Those stocks at the top,whose cumulative market capitalization is less than or equal to 90% of thetotal float-adjusted market capitalization of the sub-industry, are deemed toqualify

Membership requirements include:

 Market Capitalization: Stocks with a float-adjusted market capitalization above US$ 500 million and meet the liquidity threshold are

included in order of their float- adjusted market capitalization until thestock count reaches 21 The float-adjusted market capitalization of thesestocks must combine to be at least 90% of the total sub-industry marketcapitalization If the index still does not have enough stocks that meet thecriteria for inclusion, the minimum market capitalization requirements may

be relaxed until the other requirements have been satisfied

Liquidity Constituents must have a liquidity ratio defined by dollar value traded over the previous 12 months divided by average

market capitalization over the previous 12 months - greater than 30%.The length of time to evaluate liquidity is reduced to available tradingperiod for IPOs or spin-offs that do not have 12 months of tradinghistory

Domicile U.S companies only.

Index rebalancing occurs after the closing on the third Friday of thequarter ending month The reference date for additions and deletions is afterthe closing of the last trading date of the previous month

Additions No companies are added between rebalancing In the case

of mergers involving at least one index constituent, the mergedcompany will remain in the index if it meets all of the eligibilityrequirements The merged company will be added to the index at theweight of the pre-merger index constituent If both companies involved

in a merger are index constituents, the merged company will be added

at the weight of the company deemed the acquirer in the transaction

Deletions A company is deleted from a Select Industry index if the

S&P Total Market Index drops the constituent If a constituent deletioncauses the number of companies in the relevant index to fall below 21,

no addition will be made to the index until the next rebalancing At thattime, the entire index will be rebalanced based on all eligibility criteria,including minimum number of companies

2.1.1.4 Index calculation

The index series is equal-weighted and calculated by the divisor

methodology used in all Standard & Poor’s equity indices

The initial divisor is set to have a base index value of 1000 onDecember 15, 2000 The index value is simply the index market value divided

by the index divisor:

In which N is the number of stocks in the index

At the beginning of each quarterly rebalancing, Index Shares are set sothat each constituent has equal weight

In which K is an arbitrary or nominal value used to ensure eachcompany’s ―shares‖ number is derived to establish equal weighting in theindex.

In order to maintain index series continuity, it is also necessary toadjust the divisor at each rebalancing

(Index Value)before rebalance = (Index Value)after rebalanceTherefore,

2.1.2 Dow Jones U.S Industry Indices

2.1.2.1 Index description

The Dow Jones U.S Industry Index is a broad-based but investablemeasure of the U.S stock market, intended for use as the basis of investmentproducts The index aims to consistently represent the top 95% of U.S.companies based on float-adjusted market capitalization, excluding the verysmallest and least-liquid stocks Each industry indices has base value of 100

as of December 31, 1991

2.1.2.2 Sector classification system

Industry indices are constructed by categorizing the component stocks

of the Dow Jones U.S Index into the 10 Industries, 19 Super sectors, 41Sectors and 114 Subsectors of the Industry Classification Benchmark (ICB) Aseparate index is maintained for each group at each of the four levels.Companies are classified into Subsectors, the most specific level ofclassification, based on their primary source of revenue The Subsectors are

rolled up into Sectors, which in turn are rolled up into Super sectors andfinally into Industries, the broadest level of classification.

2.1.2.3 Index membership

The index universe is defined as all stocks traded on the major U.S.stock exchanges, minus any non-common issues and illiquid stocks For eachindustry index, the top-ranked stocks in terms of size and liquidity are chosenfrom the corresponding selection list as components:

1 The index universe is sorted by free-float market capitalization

2 Stocks in the top 95% of the index universe by free-float marketcapitalization are selected as components of the Dow Jones U.S Index,skipping stocks that fall within the bottom 1% of the universe by free-floatmarket capitalization and within the bottom 01% of the universe by turnover

1985 at a base value of 250.00

2.1.3.2 Sector classification system

NASDAQ Financial-100 Index employs the Industry ClassificationBenchmark (ICB) system to classify its members as belonging to financialsector

2.1.3.3 Index membership

Index eligibility is limited to specific security types only The securitytypes eligible for the Index include foreign or domestic common stocks,ordinary shares, ADRs, shares of beneficial interest or limited partnershipinterests, and tracking stocks Security types not included in the Index areclosed-end funds, convertible debentures, exchange traded funds, preferredstocks, rights, warrants, units and other derivative securities

To be eligible for inclusion in the Index, a security must be listed onThe NASDAQ Stock Market and meet the following criteria:

The security’s U.S listing must be exclusively on the NASDAQ Global

Select Market or the NASDAQ Global Market (unless the security wasdually listed on another U.S market prior to January 1, 2004 and hascontinuously maintained such listing);

The issuer of the security must be classified according to the Industry Classification Benchmark (ICB) as Financials;

The security may not be issued by an issuer currently in bankruptcy proceedings;

If the issuer of the security is organized under the laws of ajurisdiction outside the U.S., then such security must have listedoptions on a recognized options market in the U.S or be eligible forlisted options trading on a recognized options market in the U.S.;

Only one class of security per issue is allowed;

The issuer of the security may not have entered into a definitiveagreement or other arrangement which would likely result in thesecurity no longer being Index eligible;

The issuer of the security may not have annual financial statements with an audit opinion that is currently withdrawn;

The issuer of the security must have ―seasoned‖ on NASDAQ oranother recognized market (generally, a company is considered to beseasoned by NASDAQ if it has been

Listed on a market for at least two years; in the case of spin-offs, the operating history of the spin-off will be considered); and

If a security would otherwise qualify to be in the top 25% of theissues included in the Index by market capitalization for the six priorconsecutive month-ends, then a one year ―seasoning‖ criteria wouldapply

2.1.3.4 Index calculation

The NASDAQ Financial-100 Index is a market capitalization-weightedindex The value of the Index equals the aggregate value of the Index shareweights, also known as the Index Shares, of each of the Index Securitiesmultiplied by each such security’s last sale price, and divided by the Divisor

of the Index The Divisor serves the purpose of scaling such aggregate value

to a lower order of magnitude which is more desirable for Index reportingpurposes If trading in an Index Security is halted while the market is open,the last traded price for that security is used for all index computations until

trading resumes If trading is halted before the market is open, the previousday’s last sale price is used The formula for Index value is as follows:

Aggregate Adjusted Market Value/Divisor

The Index is ordinarily calculated without regard to cash dividends onIndex securities The Index is calculated during the trading day and isdisseminated every 15 seconds from 09:30:15 to 17:16:00 ET through theNASDAQ Index Dissemination Services (NIDSSM) The closing value of theIndex may change up until 17:15:00 ET due to corrections to the last saleprice of the Index Securities

2.1.4 MorningStar sector Indices

2.1.4.2 Sector classification system

The Morningstar Sector Structure is a three-tiered classification systemthat groups companies engaged in similar lines of business by varying levels

of granularity

The Morningstar sector index family consists of a comprehensive set ofindices that collectively target 97% coverage of the U.S equity markets TheMorningstar sector index family consists of:

A broad market index: Morningstar US Market Index

Three Morningstar Super Sector Indices

12 Morningstar Industry Sector Indices

Source: MorningStar, http://www.morningstar.com/

Figure 2.1: Summary of Morningstar sector index family

2.1.4.3 Index membership

To qualify for inclusion in the Morningstar sector indices, a security must meet the following criteria:

 It must trade on one of the three major exchanges—the NYSE,

AMEX, or NASDAQ exchange

 The issuing company’s country of domicile should be the U.S or theissuing company’s primary stock market activities are carried out in theU.S

 Securities that have more than 10 non-trading days in the prior quarterare excluded

 The following security types do not qualify:

American Depository Receipts and American Depository Shares

Fixed-dividend shares

Convertible notes, warrants, and rights

Tracking stocks

Limited partnerships and holding companies

 A security must be among the top 75% of the companies in theinvestable universe based on its liquidity score A security’s liquidity score

is the average of its ranks on each of the following measures:

The average monthly trading volume in $US during the six calendarmonths immediately prior to reconstitution or, in the case of corporateentities younger than six months, since the security was first issued(partial month periods are prorated by number of trading days in themonth)

The lowest 2 months’ total trading volume during the six calendarmonths immediately prior to reconstitution (the months need not besequential)

2.1.4.4 Index calculation

The value (price) and total return of an index is calculated using the following formula

The above formulas can be simplified as: Index (t) = M(t)/D(t)

B(t) = adjusted base date market capitalization of the index at time (t)

2.1.5 NYSE Sector Indices

2.1.5.1 Index description and sector classification system

The NYSE Sector Indices are subsets of the NYSE Composite Index

and consist of three separate indices representing the following market

sectors: Energy, Financial, and Health Care Component in each of the three

NYSE Sector Indices include NYSE-listed common stocks that are classified

according to the Dow Jones Global Classification System These indices are

introduced to give investors and issuers a more defined snapshot of key

segments of the NYSE marketplace The three new sector indices supersede

the old NYSE sub-indices – Industrial, Financial, Transportation, and Utilities

indices

Each of the three NYSE Sector Indices has a base date of December 31,

2002 The closing market value on this date was given an index value of

5,000 (December 31, 2002=5,000)

2.1.5.2 Index membership

A company must have its shares listed on the New York StockExchange in order to be eligible for inclusion in any of the NYSE SectorIndices Only common stocks, ADRs, REITs and tracking stocks listed on theNYSE are eligible for inclusion; multiple classes of shares can also beincluded in the Composite Preferred stocks, closed-end funds, exchange-traded funds, trust units, shares of beneficial interest, limited partnerships, andderivative securities such as warrants and rights are not eligible

1 Additions

Additions to the NYSE Sector Indices can be a result of new NYSElistings, IPOs, spin-offs and takeovers New listings and IPOs are added to anNYSE Sector Index at the close of trading on their first day of trading on theNYSE If an index constituent spins off a portion of its business to form one

or more new companies, all new companies will be immediately included inthe Sector Index If an index constituent merges with another company, thenewly formed company becomes a member of the Sector Index after the close

of trading on the effective date of the merger provided it meets themembership criteria

2 Deletions

Deletions from the NYSE Sector Indices can be a result of NYSEdelisting, takeovers, and bankruptcies A stock delisted from the NYSE isdeleted from a NYSE Sector Index on the day it stops trading on theExchange If an index component is taken over by another componentcompany, the former will be removed from the index immediately upon

completion of the takeover A component company in bankruptcy proceedingsthat continue to trade will stay in the index until delisted.

2.1.5.3 Index calculation

The NYSE Sector Indices are computed as follows:

The above mentioned formula can be simplified as:

Where

Dt = divisor at time (t) = Bt/base index value

n = the number of stocks in the index

pi0 = the closing price of stock i at the base date (December 31, 2002)

qi0 = the number of shares of company i at the base date (December 31,2002)

pit = the price of stock i at time (t)

qit = the number of shares of company i at time (t)

Ct = the adjustment factor for the base date market

capitalization t = the time the index is computed

Mt = market capitalization of the index at time (t)

Bt = adjusted base date market capitalization of the index at time (t)

2.1.6 Comparison and conclusion of international sector indices 2.1.6.1 Comparison

Table 2.1: Comparison of international sector indices

Index Nam

industry indices

U.S.

Industry Indices

Sector Indices