Presentation on theme: "2 Asset Classes and Financial Instruments Bodie, Kane and Marcus"— Presentation transcript:
12 Asset Classes and Financial Instruments Bodie, Kane and Marcus Essentials of Investments 9th Global Edition
22.4 Stock and Bond Market Indexes UsesTrack average returnsCompare performance of managersBase of derivativesFactors in constructing/using indexRepresentative?Broad/narrow?How is it constructed?
32.4 Stock and Bond Market Indexes Construction of IndexesHow are stocks weighted?Price weighted (DJIA)Market value weighted (S&P 500, NASDAQ)Equally weighted (Value Line Index)How much money do you put in each stock in the index?
42.4 Stock and Bond Market Indexes Constructing Market IndexesWeighting schemesPrice-weighted average: Computed by adding prices of stocks and dividing by “divisor”Market value-weighted index: Return equals weighted average of returns of each component security, with weights proportional to outstanding market valueEqually weighted index: Computed from simple average of returns
52.4 Stock and Bond Market Indexes PriceBQuantityBP1Q1A$1040$15B508025160C140150Price-Weighted SeriesTime 0 index value: ( )/3 = 200/3 = 66.7Time 1 index value: ( )/Denom = 66.67Denominator =Time 1 index value: ( )/ = 72.38Other problems:Similar % change movements in higher-price stocks cause proportionally larger changes in the indexSplits arbitrarily reduce weights of stocks that split in index
62.4 Stock and Bond Market Indexes PriceBQuantityBP1Q1A$1040$15B508025160C140150Value-Weighted SeriesIndexV =Equal-Weighted Serieswlog invest $300 in eachIndexE =
72.4 Stock and Bond Market Indexes Case 1Case 2StockPBQBP1Q1A$1040$12B10080C5020060Why do the two differ?Case 1: 20% change in price of small-cap firmIndexV =wlog invest $100 in each stockIndexE =
82.4 Stock and Bond Market Indexes Case 1Case 2StockPBQBP1Q1A$1040$12B10080C5020060Case 1 VW =Case 1 EW =Why do the two differ?Case 2: 20% change in price of large-cap firmIndexV =Assume $100 investment in each stockIndexE =