6 Stock Market Index

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6 Stock Market Index

  1. 1. Stock Market Index
  2. 2. Importance of Stock Market Index • It is a standard of comparison to judge the performance of individual investor • To evaluate alternative investments • To measure the market rates of return • To predict the market movements
  3. 3. Construction of Stock Market Index • A stock market average is a weighted or unweighted average stock price • A price index number is a pure number that is void of any unit of measurement • Indexes are more useful as they are designed to avoid distortions • Index numbers are constructed from a base date value to serve as the index’s starting point with a perspective to have a time-series of index numbers
  4. 4. Factors affecting the construction of stock market index • Sample size – Sample should be large enough to be statistically significant • Representativeness – It should be representative of total population and should possess characteristics of interest • Base year – It should be a normal year
  5. 5. Factors affecting the construction of stock market index • Weighting criteria – Equally Weighted Series – Price Weighted Series – Market value Weighted Series • Convenient units – An index should be stated in convenient units to facilitate answering questions • Uniform definition – An index should maintain continuity and there should not be a change in the way an index is constructed
  6. 6. Factors affecting the construction of stock market index • Economical – Computational costs are low but one should keep in mind economies in gathering and updating data • Timeliness – A price indicator should reflect all changes in the underlying prices immediately • Descriptive title – A price indicator should bear a title that suggests what it represents unambiguously
  7. 7. Example--- Quantity Base Price Current Stocks price A 60,000 30 45 B 20,000 25 80 C 90,000 65 85
  8. 8. Calculations • Equally weighted series--- • 1/3 (45/30 + 80/ 25 + 85 / 65) = 2.0033 • Price weighted series--- • (45 + 80 + 85)/ )(30 + 25 + 65) = 1.75 • Market value weighted series--- • (60 000*45 + 20 000*80 + 90 000* 85) / (60 000*30 + 20 000*25 + 90 000* 65) = 1.46
  9. 9. Popular Stock Market Indexes in India Index Sample Base Base Weighting size Year Value type BSE sensex 30 1978-79 100 Value weighted CNX Nifty 50 Nov 3, 100 -do- 1995 Economic 72 1984-85 100 Equal times weighted Financial Exp 100 1979-80 100 Value RBI Index 338 1981-82 100 Un-weighted BSE National 100 1983-84 100 Value
  10. 10. Popular Stock Market Indexes Abroad Index Sample Base Base Weighting size Year Value type DJIJ 30 1938 100 Price S & P Composite 500 1941-42 10 Value NYSE 2818 1965 50 Value NASDAQ 5575 - - Value Tokyo 1800 - - Value
  11. 11. The Dow Jones Industrial Average • (DJIA) • In 1884, Charles Dow started publishing the daily average of eleven stocks in WSJ • In 1928 the sample size increased to 30 and it remains there today. • The companies that Mr. Dow selected were not representative sample of that time • DJIA may be a misnomer because small, medium and new companies do not figure in it
  12. 12. The Dow Jones Industrial Average • Stock dividend and stock split have a predictable impact on the prices of equity shares but do not change the total market value of all shares outstanding • In 1928 the original 30 stocks prices were simply summed up and total was divided by 30 to obtain DJIA value
  13. 13. Maintaining a Price Index • Three common problems that require revisions are: • Adjustment for stock dividends and stock splits • Changing the number of stocks in the sample • Making substitutions to replace securities that become unsatisfactory • Stocks are added or deleted when they are listed or delisted, mergers, liquidations etc.

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