DJIA and S&P500 Example
Consider two companies:
1. Initial price of $50
2. Initial price of $100
Consider a portfolio composed of two shares of stock, one for each company. This would cost $150.
DJIA
Now consider a 15% increase in the price of stock 1:
The increase in stock 1 is $7.50.
The value of the portfolio is $157.50.
So the value of the portfolio increases by 5%
Now consider a 15% increase in the price of stock 2:
The increase in stock 2 is $15.00.
The value of the portfolio is $165.
So the value of the portfolio increases by 10%
Behaviour of higher priced stock dominates the movement of DJIA.
S&P500
Market value, or market capitalization:
1. $50 *100 million shares outstanding ($5 billion)
2. $100*10 million shares outstanding ($1 billion)
Together they worth $6 billion.
Now consider a 15% increase in the price of stock 1:
The market value for stock 1 goes up to $5.75 billion
The value of the portfolio is $6.75 billion.
Thus, the value of the portfolio increases by 12.5%
Now consider a 15% increase in the price of stock 2:
The market value for stock 2 goes up to $1.15 billion.
The value of the portfolio is $6.15 billion.
Thus, the value of the portfolio increases by 2.5%