1. Certificate for Introduction to Securities & Investment (Cert.ISI) Unit 1  London Stock Exchange indices o FTSE 100 o FTSE 250 o FTSE 350 o FTSE All Share 29cis Lesson 29:  The types and uses of a stock exchange index

2. Stock indices Stock indices provide a snapshot of how share prices are performing in a particular market, or across several markets Stock indices can measure price movements across:  A selection of shares from several different stock markets around the world  All shares listed on a single stock market  A selection of shares from a single stock market  Shares classified according to market capitalisation o Large-cap o Mid-cap o Small-cap  Shares classified according to business type o Industrials o Utilities o Pharmaceuticals, etc  Shares classified according to business philosophy o “Green” stocks (sustainability, etc) o “Sin-free” stocks (no earnings from alcohol, tobacco, gambling, etc) A stock index calculates the aggregate price movement of its targeted stocks on a daily basis, providing a single figure for ease of comparison

3. Why are stock indices useful? By the end of a normal trading day:  Some share prices may have moved up sharply on very low volume  This might be due to one maverick trade that does not represent the market’s view of the stock  Some share prices may have moved down sharply because the dividend has just been paid  Some sector-specific news might have pushed up the share prices of some important stocks, while the rest of the market drifted lower  For instance, the government Regulator might have announced a higher-than- expected tariff increase for the electricity supply companies It is very difficult an investor to gauge the overall performance of the market from looking individual share price movements A stock index aims to smooth out these anomalies and provide a consistent picture of the mood of the market. They “track” the market through its ups and down over a period of time.

4. Why are stock indices useful? Vodafone Barclays BP This chart shows the movement of the FTSE 100 index over the course of the same day FTSE 100 These charts show the movement of three, key, large-cap stocks on the London Stock Exchange over the course of a single trading day:  How to sum up the performance of the stock market as a whole that day?  This shows investors how the whole market performed

5. Stock indices for performance comparison Most equities investors build up a portfolio of stocks. It would be very foolhardy to place all the money in the shares of a single company Some investors are stock pickers  They try to pick out individual companies which have the best prospects  These companies might be chosen from across several different countries, e.g. o BP – UK o France Telecom – France o Henkel – Germany o Fiat – Italy o Telefonica – Spain o Ryanair – Ireland o Electrolux – Sweden o Credit Suisse –Switzerland o InBev – Belgium o Philips – Netherlands Some investors are market pickers  They try to pick out the individual markets which have the best prospects  An investor might choose a portfolio to gain broad exposure to a market which looks very cheap “right across the board”, e.g. UK at the end of 2008 o RBS o Lloyds TSB o British Airways o National Express o Severn Trent o Centrica o BT Group o Vodafone o Tesco o Barratt Devts FTSE 100

6. Stock indices for performance comparison (cont.) How does the equity investor gauge whether he /she has chosen the best stocks, or whether it is time to switch into others? The stock picker:  The stock-picker would compare the performance of the share with the relevant local index  France Telecom: the CAC 40 Index measures shares prices traded on the Paris Bourse The market picker:  The investor who has tried to pick a market would compare the performance of an index with the performance of another index over the same period  The FTSE 100 measures the share prices of the largest 100 UK companies  Over the past six months, the FTSE 100 has under-performed the Dow Jones Industrial Index in New York FTSE 100 vs DJI

7. UK stock indices In the UK, stock indices are calculated and published by FTSE International, originally a joint venture between The Financial Times and the London Stock Exchange. The main FTSE indices are: FTSE 100  An index of the largest 100 UK companies, representing about 70% of the whole UK stock market by value  This index is commonly referred to as the “Footsie” FTSE 250  An index of the next 250 medium- or middle-sized companies below the 100  The FTSE 250 is the main mid-cap index FTSE 350  A combination of the 100 and 250 indices  The FTSE 350 is broken down into industry sectors, such as Retailing and Transport FTSE All Share  Covers over 600 companies, including the 350  The FTSE All Share accounts for about 98% of the UK market by value  It is often used as the benchmark against which diversified share portfolios are measured

8. Keeping UK stock indices up-to-date The FTSE 100, 250 and 350 indices are reviewed every three months to ensure that their constituent stocks reflect their intended sections of the market  Share prices can change significantly over a three month period  Share price movements inevitably impact market capitalisation o Market capitalisation is the share price multiplied by the number of shares listed  A company which has enjoyed a rapid increase in market cap may replace a company whose market cap has been static or is falling Note: the FTSE All Share is reviewed annually

9. Tracker funds Surprisingly few stock-pickers manage to “outperform the index”. The prices of the shares they have chosen perform less well in aggregate than the market(s) as a whole (as measured by the relevant index) Many investors take the view that if so many professional fund managers fail to beat the index, there is no point in paying them fees to pick stocks in the first place Performance of balanced managed pension funds vs the stock-market  Tracker funds try to build portfolios of stocks that move in line with the market as a whole A FTSE All Share tracker fund might hold 150 of the index’s 630 constituent stocks and aim to match the movements of the index with 95% accuracy  They might as well invest in the market as a whole – buy a “tracker” fund

10. Tracker funds and index constituents About 35% of all UK pensions funds (by value) track indices. Therefore the quarterly review of the constituent stocks of an index can have a major impact on individual share prices. When a stock is dropped from the FTSE 100 index, tracker funds benchmarked against the FTSE 100 no longer have any need to own it  With so many tracker funds selling the stock, the share price is likely to fall  When a stock is elevated to the FTSE 100 index, tracker funds benchmarked against the FTSE 100 will probably have to include it in their portfolios for the first time  With so many tracker funds buy the stock, the share price is likely to rise A recent academic study in the US found that the prices of stocks added to the S&P 500 index between 1990 and 2005 rose by almost 9% around the time of their inclusion in the index. Stocks deleted from the index have tumbled by even more.

11. The importance of index inclusion Investors understand very well the importance of index inclusion, and will keep close watch on the market caps of stocks  They may buy the shares of likely candidates for inclusion in an index  They may sell the shares of companies likely to be dropped from an index Companies try very hard to keep they shares prices high enough to remain constituents of key stock indices  This is not only for the prestige: borrowing costs can be lower for FTSE 100 companies

12. Stock indices as a measure of economic sentiment Economic growth is very dependent on people’s and businesses’ confidence in the future. This confidence determines how much they are willing to spend now or save for a rainy day later. Central banks look closely at confidence indicators when setting interest rates Stock indices are a good early indicator of confidence levels Investors try to buy shares at the bottom, just before an upturn  Investors will look for signs that “the corner has been turned”  Companies’ order-books have stopped shrinking  Decisions are taken to invest in additional capacity  Export prices are improving  Sometimes investors just get a “gut feel” that the economy is improving Investors try to sell shares at the top of the market just before a downturn  Investors will look for signs that profits are peaking  Order-books are growing at a much slower rate  Investment decisions are suddenly put on hold  Margins are being cut to maintain market share  Sometimes investors become uneasy that prices have moved up too far, too fast and sell in order to lock in their profit

13. Stock indices as a leading indicator The stock market will often anticipate the movement in the economy by several months.  Investors start selling their shares long before the peak in economic growth  Investors start buying shares long before the bottom of the trough in economic activity

14. World stock indices Some of the other main indices that are regularly quoted in the financial press are: CountryName Number of constituent stocks USADow Jones Industrial Average (DJIA or “The Dow”): Providing a narrow view of the US stock market 30 USAStandard & Poor’s 500 (S&P 500): Providing a wider view of the US stock market 500 USANasdaq Composite: Focusing on the shares traded on Nasdaq, including many technology companies 3,000+ JapanNikkei 225225 FranceCAC 4040 GermanyXetra Dax30