Chapter 4Security Market

Indicator Series

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1. As benchmarks to evaluate the performance of professional money managers

2. To create and monitor an index fund3. To measure market rates of return in

economic studies4. For predicting future market movements by

technicians 5. As a substitute for the market portfolio of

risky assets when calculating the systematic risk of an asset

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The sample size breadth (be representative) source

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Weighting of sample members1. price-weighted series2. market value-weighted series3. unweighted (equally weighted)

series

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Computational procedure1. arithmetic average2. compute an index and have all

changes reported in terms of the basic index.

3. geometric average

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Price Weighted Series Dow Jones Industrial Average (DJIA) Nikkei-Dow Jones Average (225 stocks on the First

Section of Tokyo Stock Exchange)Market-Value-Weighted Series NYSE Composite S&P 500 Index and more…

Unweighted Price Indicator Series Value Line Averages Financial Times Ordinary Share Index

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See Exhibit 4.5 Summary of Stock Market Indexes

Price-weighted average of thirty large well-known industrial stocks, leaders in their industry, and listed on NYSE

Total the current price of the 30 stocks and divide by a divisor (adjusted for stock splits)

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After Three-for One Before Split Split by Stock A Prices PricesA 30 10B 20 20C 10 10 60/3 = 20 40/X = 20

X = 2 (New Divisor)

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Exhibit 4.1

Period T+ 1 .

Period T Case A Case B A 100 110(+10%) 100B 50 50 50C 30 30

33(+10%)Sum 180 190 183Divisor 3 3 3Average 60 63.3 61Percentage Change 5.5% 1.7% 9

Exhibit 4.2

Limited to 30 non-randomly selected blue-chip stocks (see http://www.dowjones.com/ for component stocks)

Does not represent a vast majority of stocks

The divisor needs to be adjusted every time one of the companies in the index has a stock split

Introduces a downward bias by reducing weighting of fastest growing companies whose stock splits

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Market Value

= Number of Shares Outstanding X Current Market Price

Assign an beginning index value (e.g. 100) and new market values are compared to the base index

Automatic adjustment for splits

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where:Indext = index value on day tPt = ending prices for stocks on day tQt = number of outstanding shares on day tPb = ending price for stocks on base dayQb = number of outstanding shares on base day

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ValueIndex BeginningIndex t

bb

tt

QP

QP

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Exhibit 4.3

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Exhibit 4.4 20% increase in Stock A and C

All stocks carry equal weight regardless of price or market value

May be used by individuals who randomly select stocks and invest the same dollar amount in each stock

Some use arithmetic average of the percent price changes for the stocks in the index

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Exhibit 4.8

Styles (size and type) Small-cap growth Mid-cap growth Large-cap growth Small-cap value Mid-cap value Large-cap value

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Universe of bonds is much broader than that of stocks.

Range of bond quality varies from U.S. Treasury securities to bonds in default.

Bond market changes constantly with new issues, maturities, calls, and sinking funds

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Bond prices are affected by duration, which is dependent on maturity, coupon, and market yield.

Correctly pricing individual bond issues without current and continuous transaction prices available poses significant problems.

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rated BBB or higher Relationship among these bonds is

strong (correlations average 0.95) Returns for all these bonds are

driven by aggregate interest rates - shifts in the government yield curve

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Non investment-grade bonds rated BB, B, CCC, CC, C

Relationship among high-yield bond indexes is weaker than among investment grade indexes

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Do Problem 1, 2, 6. Good reference: Appendix-Foreign

Stock Market Indexes

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