1. Stock Market Index

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. 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. 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. 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. 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. Example---
Quantity Base Price Current
Stocks price
A 60,000 30 45
B 20,000 25 80
C 90,000 65 85

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. 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. 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. 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. 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. 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.