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 South-Western / Thomson Learning © 2004 13 - 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 South-Western / Thomson Learning © 2004 13 - 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 South-Western / Thomson Learning © 2004 13 - Index Construction: Price Weighting Insert Table 13-2 here South-Western / Thomson Learning © 2004 13 - 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 South-Western / Thomson Learning © 2004 13 - Index Construction: Equal Weighting Insert Table 13-3 here South-Western / Thomson Learning © 2004 13 - 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) South-Western / Thomson Learning © 2004 13 - Index Construction: Capitalization Weighting Table 13-4 DO THIS IN TWO SLIDES South-Western / Thomson Learning © 2004 13 - Index Construction: Capitalization Weighting Table 13-4 DO THIS IN TWO SLIDES South-Western / Thomson Learning © 2004 13 - 10 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 South-Western / Thomson Learning © 2004 13 - 11 Popular Indexes: Stock Indexes Insert Figure 13-1 here South-Western / Thomson Learning © 2004 13 - 12 Popular Indexes: Stock Indexes Insert Table 13-7 here South-Western / Thomson Learning © 2004 13 - 13 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 South-Western / Thomson Learning © 2004 13 - 14 Popular Indexes: Stock Indexes Insert Figure 13-2 here South-Western / Thomson Learning © 2004 13 - 15 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 South-Western / Thomson Learning © 2004 13 - 16 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 South-Western / Thomson Learning © 2004 13 - 17 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 South-Western / Thomson Learning © 2004 13 - 18 Review Index Construction Price Weighting Equal Weighting Capitalization Weighting Popular Indexes Stock Indexes Fixed Income Indexes International Indexes South-Western / Thomson Learning © 2004 13 - 19 ... 13 - 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