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Stock Market Index
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
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
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
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
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
Example---
856590,000C
802520,000B
453060,000A
Current price
Base PriceQuantityStocks
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
Popular Stock Market Indexes in India
Value1001983-84100BSE National
Un-weighted1001981-82338RBI Index
Value1001979-80100Financial Exp
Equal weighted
1001984-8572Economic times
-do-100Nov 3, 1995
50CNX Nifty
Value weighted
1001978-7930BSE sensex
Weighting type
Base Value
Base Year
Sample size
Index
Popular Stock Market Indexes Abroad
Value --1800Tokyo
Value--5575NASDAQ
Value5019652818NYSE
Value101941-42500S & P Composite
Price 100193830DJIJ
Weighting type
Base Value
Base Year
Sample size
Index
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
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
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.
