Finance Chapter 4 Share Index Computation Equally Weighted Index Exhibit Arithmetic And Geometric Means Exhibit

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CHAPTER 4

SECURITY MARKET INDEXES AND INDEX FUNDS

4.1 Uses of Security Market Indexes

▪ As benchmarks to evaluate the performance of professional money managers

4.2 Differentiating Factors in Constructing Market Indexes

4.2.1 The Sample – should be representative of the total population

4.2.2 Weighting of Sample Members

▪ Price-weighted index

4.2.3 Computational Procedures

▪ Arithmetic average

4.3 Stock-Market Indexes (Exhibit 4.7, 4A.1)

4.3.1. Price-Weighted Index

1. Dow Jones Industrial Average (Exhibit 4.1, 4.2)

▪ Oldest and best-known of the stock market indexes

▪ Computation of DJIA – sum of the prices of 30 blue-chips stocks divided by adjusted

2. Nikkei-Dow Jones Average (Nikkei Stock Average Index)

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4.3.2 Value-Weighted Index

4.3.3 Unweighted Index

▪ General computational procedure – all stocks in an unweighted index carry equal weight

4.3.4 Fundamental Weighted Index

▪ Some observers have suggested other measures of a company’s economic footprint.

▪ Firms and authors can and have created indexes with single variables or a different set of

4.3.5 Style Indexes

▪ Small-cap growth

4.3.6. Global Equity Indexes (Exhibit 4.8, 4A.2)

1. FT/S&P-Actuaries World Indexes

3. Dow Jones World Stock Index (Exhibit 4.9)

4.4 Bond Market Indexes

1. U.S. Investment-Grade Bond Indexes (Exhibit 4.11)

3. Global Government Bond Market Indexes (Exhibit 4.12)

4.5 Composite Stock-Bond Indexes

4.6 Comparison of Indexes over Time

4.6.1 Correlations between Monthly Equity Price Changes (Exhibit 4.13)

▪ High, positive correlation between the S&P 500 and several comprehensive U.S. equity

4.6.2 Correlations between Monthly Bond Index Returns

▪ Strong, positive correlations between longer-term, U.S. investment-grade bond indexes.

4.7 Investing in Security Market Indexes

1. Index Funds

▪ For an indexed portfolio, the fund manager will typically attempt to replicate the composition

of the particular index and buy the exact securities comprising the index in their exact

weights and then alter those positions anytime the index composition is changes.

2. Exchange-Traded Funds (Exhibit 4.15)

▪ ETFs are depository receipts that give investors a pro rata claim on the capital gains and cash

flows of the securities that are held in deposit by the financial institution that issued the

certificates.

▪ Examples include

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▪ Advantages of ETFs over index mutual funds:

– Can be bought and sold (and short sold) like common stock through an organized

▪ ETF disadvantages:

– Brokerage commissions