Chapter 4 Security Market Indicator Series 1

1. As benchmarks to evaluate the performance of professional money managers 2. To create and monitor an index fund 3. To measure market rates of return in economic studies 4. For predicting future market movements by technicians 5. As a substitute for the market portfolio of risky assets when calculating the systematic risk of an asset 2

The sample  size  breadth (be representative)  source 3

Weighting of sample members 1. price-weighted series 2. market value-weighted series 3. unweighted (equally weighted) series 4

Computational procedure 1. arithmetic average 2. compute an index and have all changes reported in terms of the basic index. 3. geometric average 5

Price Weighted Series  Dow Jones Industrial Average (DJIA)  Nikkei-Dow Jones Average (225 stocks on the First Section of Tokyo Stock Exchange) Market-Value-Weighted Series  NYSE Composite  S&P 500 Index and more … Unweighted Price Indicator Series  Value Line Averages  Financial Times Ordinary Share Index 6 See Exhibit 4.5 Summary of Stock Market Indexes

 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 (adjusted for stock splits) 7

After Three-for One Before Split Split by Stock A Prices Prices A B C /3 = 20 40/X = 20 X = 2 (New Divisor) 8 Exhibit 4.1

Period T+ 1. Period T Case A Case B A (+10%)100 B C (+10%) Sum Divisor Average Percentage Change 5.5% 1.7% 9 Exhibit 4.2

 Limited to 30 non-randomly selected blue- chip stocks (see for component stocks)  Does not represent a vast majority of stocks  The divisor needs to be adjusted every time one of the companies in the index has a stock split  Introduces a downward bias by reducing weighting of fastest growing companies whose stock splits 10

 Market Value = Number of Shares Outstanding X Current Market Price  Assign an beginning index value (e.g. 100) and new market values are compared to the base index  Automatic adjustment for splits 11

where: Index t = index value on day t P t = ending prices for stocks on day t Q t = number of outstanding shares on day t P b = ending price for stocks on base day Q b = number of outstanding shares on base day 12

13 Exhibit 4.3

14 Exhibit % increase in Stock A and C

 All stocks carry equal weight regardless of price or market value  May be used by individuals who randomly select stocks and invest the same dollar amount in each stock  Some use arithmetic average of the percent price changes for the stocks in the index 15

16 Exhibit 4.8

 Styles (size and type)  Small-cap growth  Mid-cap growth  Large-cap growth  Small-cap value  Mid-cap value  Large-cap value 17

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 Universe of bonds is much broader than that of stocks.  Range of bond quality varies from U.S. Treasury securities to bonds in default.  Bond market changes constantly with new issues, maturities, calls, and sinking funds 19

 Bond prices are affected by duration, which is dependent on maturity, coupon, and market yield.  Correctly pricing individual bond issues without current and continuous transaction prices available poses significant problems. 20

 rated BBB or higher  Relationship among these bonds is strong (correlations average 0.95)  Returns for all these bonds are driven by aggregate interest rates - shifts in the government yield curve 21

 Non investment-grade bonds  rated BB, B, CCC, CC, C  Relationship among high-yield bond indexes is weaker than among investment grade indexes 22

 Do Problem 1, 2, 6.  Good reference: Appendix-Foreign Stock Market Indexes 23