Chapter 4
Security Market
Indicator Series
1
1.
2.
3.
4.
5.
As benchmarks to evaluate the performance of
professional money managers
To create and monitor an index fund
To measure market rates of return in economic
studies
For predicting future market movements by
technicians
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
See Exhibit 4.5 Summary of Stock Market Indexes
6


Price-weighted average of thirty large wellknown 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)
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Exhibit 4.1
After Three-for One
Before Split
Split by Stock A
Prices
Prices
A
30
10
B
20
20
C
10
10
60/3 = 20
40/X = 20
X = 2 (New Divisor)
8
Exhibit 4.2
Period T+ 1
Case A
Case B
110(+10%) 100
50
50
30
33(+10%)
190
183
3
3
63.3
61
5.5%
1.7%
.
Period T
A
100
B
50
C
30
Sum
180
Divisor
3
Average 60
Percentage Change
9




Limited to 30 non-randomly selected bluechip stocks (see http://www.dowjones.com/
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
Index t
PQ


P Q
t
t
b
b
 Beginning Index Value
where:
Indext = index value on day t
Pt = ending prices for stocks on day t
Qt = number of outstanding shares on day t
Pb = ending price for stocks on base day
Qb = number of outstanding shares on base day
12
Exhibit 4.3
13
Exhibit 4.4
20% increase in Stock A and C
14
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
Exhibit 4.8
16

Styles (size and type)
Small-cap growth
 Mid-cap growth
 Large-cap growth
 Small-cap value
 Mid-cap value
 Large-cap value

17
18



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

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