Analysis of Investments & Management of Portfolios

SECURITY MARKET INDEXES

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 OUR PRESENTERS

01 Apratim Bhuiyan
ID: 37017
03 Zarin Tasnim Labonno
ID: 37029

02 Mahreen Binte Islam

ID: 37030
04 Arafat Rahman Rumi
ID: 37056

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 What is a market index?
• It is an indicator that answers the question: What happened in the market
today?
• The reason for this question is that if an investor owns more than a few stocks
or bonds, it cumbersome to follow each stock or bond individually to
determine the composite performance of the portfolio.

Uses of security market indexes

1. For calculating benchmark returns to judge portfolio performance.
2. For development of an index portfolio.
3. For examining factors that influence aggregate security price movements.
4. For technical analysis, to predict future price movements.
5. To compute a security’s systematic risk by examining how its return responds to
changes in the market index.

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 Factors in Constructing Market Indexes
• The sample of firms to include
- What is the intended population that the sample is to represent? How large a
sample is needed for the index to be representative?
• Weighting system for sample members
- Should the waiting system be based on price, total firm value, or equally
weighted?
• Computational procedure
- How should the values of the index be reported and tracked (arithmetic or
geometric mean) ?

 What is the stock market index?

• A stock index or stock market index is a measurement of a section of the stock
market. It is computed from the prices of selected stocks (typically a weighted
average). It is a tool used by investors and financial managers to describe the
market, and to compare the return on specific investments.

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STOCK-MARKET
INDEXES

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Stock-Market Indexes

1. Price Weighted Index 4. Fundamental Weighted Index

2. Value Weighted Index 5. Style Indexes

3. Unweighted Index 6. Global Equity Indexes

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 Price Weighted Index
1. Dow Jones Industrial Average
• Best known, oldest, most popular index.
• 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
- Original divisor was 30
- Divisor now adjusted for stock splits and changes in the sample, so now much
smaller (about 0.132129493 in April 8, 2011)

2. Nikkei-Dow Jones Average

• It is an arithmetic mean of prices for 225 stocks on the First Section of the Tokyo Stock
Exchange (TSE) and shows stock price trends since the reopening of the TSE.

These indexes were criticized because the 30 stocks are not representative of the thousands of US
stocks and the 225 stocks only comprise about 15 percent of all stocks on the First Section.

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 Value Weighted Index
• Although the DJIA is the most popular index, the most popular type is value-weighted.
• Derive the initial total market value of all stocks used in the series.
• Market Value = Number of Shares Outstanding * Current Market Price
• Beginning index value is usually 100, new market value changes the value of the index.
• Automatic adjustment for splits.
• Weighting depends on market value.

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 Unweighted Index
• All stocks carry equal weight regardless price or market value.
• Constructed in a parallel fashion to individuals who select stocks and invest the same dollar
amount in each stock.
• Changes in the index can be reported either in terms of arithmetic or geometric means.

Fundamental Weighted Index

• A fundamentally weighted index is a type of equity index in which components are
chosen based on fundamental criteria as opposed to market capitalization.
• Fundamentally weighted indexes can base their construction on a range of
fundamental metrics, such as revenue, dividend rates, earnings or book value.

Style Indexes
• Additional indexes have been created that seek to measure the performance of
various investment styles or sectors.
- Size indexes track the performance of large-cap, mid-cap and small cap stocks.
- Other indexes track the relative performance of growth and value stocks, perhaps also
broken down into sizes.

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 Global Equity Index
• There are stock market indexes available for most individual foreign markets.
- These are closely followed within each country.
- These are difficult to compare due to differences in sample selection, weighting, or computation.
• In response, some standardized indexes have been developed
- FT/S&P Actuaries World Indexes
- Morgan Stanley Capital International World Indexes
- Dow Jones Wilshire Global Index

FT/S&P Actuaries World Indexes

• Track over 2500 securities in 3o countries.
• Covers 70% of the total value of all listed companies in each country.
• Securities included must allow direct holdings of shares by foreign nationals.
• Index is market-value weighted with a base date of December 31, 1986 = 100.
• Results are calculated daily published the following day in the Financial Times.
• Geographic subgroups are also published.

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 MSCI Indexes
• 3 international, 22 national, and 38 international industry indexes.
• Include 1673 companies listed on stock exchanges in 22 countries with a combined capitalization
representing 60 percent of the aggregate market value of the stock exchanges of these
countries. All the indexes are market value weighted.

Dow Jones Wilshire Global Indexes

• Introduced in January 1993.
• Includes 35 countries with a total of 220 companies worldwide, organized into 120 industry
groups.
• Countries are grouped into 3 groups.
• Represents over 80% of the combined capitalization of these countries.

Comparison of World Stock Indexes

• Correlations between all of the pairs of broad world indexes are nearly 1.00, indicating
that the results with the alternative world stock indexes are quite comparable.

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BOND-MARKET INDEXES

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 Bond Market Indexes
• Relatively new and not widely published.
• Growth in fixed income mutual funds increase needs for reliable benchmarks for
evaluating performance.
• Increasing interest in bond index funds, which requires an index to emulate
- Many managers have not matched aggregate bond market return.

Difficulties in Creating a Bond-Market Index

• Range of bond quality varies from US Treasury securities to bonds in default.
• Bond market changes constantly with new issues, maturities, calls and sinking funds.

• Bond prices are affected differently by changing interest rates dependent on maturity,
coupon and market yield.
• Correctly pricing individual bond issues can be a challenge without current and
continuous transaction prices available.

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 Bond-Market Indexes

-Four investment firms maintain indexes for treasury bond and

1. Investment-Grade Bond Indexes other investment grade bonds (rated BBB or higher)
-Relationship among these bonds is strong

-Non investment-grade bonds (rated BB or below)

-Several indexes have been created
2. High-Yield Bond Indexes
-Relationship among alternative high-yield indexes is weaker than
among investment grade indexes

-Global bond market dominated by government issues

3. Global Government Bond Indexes -Several indexes created by major investment firms
-Indexes have similar characteristics

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COMPOSITE STOCK- BOND
INDEXES

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 Composite Stock-Bond Indexes
• Considers the benefits of diversification with asset allocation across stocks
and bonds. It measures the performance of all securities in a given country.
• Merill Lynch-Wilshire US Capital Markets Index (ML – WCMI)
• It measures the total return performance of the combined US taxable fixed
income and equity markets.
• It is basically a combination of the Merill Lynch fixed income indexes and the
Dow Jones Total Stock Market common-stock index.

• Brinson Partners Global Security Market Index (GSMI)

• It contains US stocks and bonds as well as non-US equities and nondollar
bonds.
• It is closest to the theoretically specified “market portfolio of risky assets”
referred to in the CAPM literature.

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 Comparison of Indexes Over Time
1. Correlations Between Monthly Equity Price Changes
- Most differences are attributable to sample differences.
- High correlations between S&P 500 and several broad stock market
indexes (.98, .99).
- Lower correlations between style indexes and other broader indexes.
- Correlations between US series and other countries confirm the
wisdom of global investing since values are often much lower.

2. Correlations Among Monthly Bond Indexes

- Among investment-grade bonds correlations range from 0.94 to 0.98.
- Significantly lower correlation between investment grade and high yield
indexes ( about 0.49 ).
- Low correlation in global returns to US returns (about 0.35) support
global diversification.

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THE END

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