Stock market indexes are used to evaluate market performance and make comparisons. They are constructed using a representative sample of stocks, with weighting based on factors like market value. Maintaining representative samples over time requires adjustments for stock splits and substitutions to replace delisted stocks. Popular US indexes include the Dow Jones Industrial Average (DJIA) and S&P 500, while in India examples are the BSE Sensex and Nifty 50.

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.