1. SECURITY MARKET INDICATORS

2. What is an indicator series?
It is an index that answers the question: What happened in the market today?

3. Uses of Security-Market Indexes
For calculating benchmark returns to judge portfolio performance
For development of an index portfolio
For examining factors that influence aggregate security price movements
For technical analysis, to predict future price movements
To compute a security’s systematic risk by examining how its return responds to changes in the market index

4. Factors in Constructing Market Indexes
The sample of firms to include
What is the intended population that the sample is to represent? How large a sample is needed for the index to be representative?
Weighting system for sample members
Should the weighting system be based on price, total firm value, or equally weighted?
Computational procedure
How should the values of the index be reported and tracked (arithmetic or geometric mean)?

5. Stock-Market Indicator Series
Price-Weighted Series
Dow Jones Industrial Average (DJIA)
Value-Weighted Series
NYSE Composite
S&P 500 Index
Russell Indexes
Willshire 5000 Index
Equal-Weighted Series
Value Line Averages

6. Dow Jones Industrial Average (DJIA)
Best-known, oldest, most popular index
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
Original divisor was 30
Divisor now adjusted for stock splits and changes in the sample, so now much smaller (about in March 2002)

7. Criticism of the DJIA Sample used is limited Price-weighted series
30 non-randomly selected blue-chip stocks are not representative of the 1800 NYSE listed stocks
Price-weighted series
Similar to assuming an investment of one share per stock
Places more weight on higher-priced stocks rather than those with higher market values
Introduces a downward bias in DJIA by reducing weight of growing companies whose stock splits

8. Value-Weighted Series
Although the DJIA is the most popular index, the most popular type is value-weighted.
Derive the initial total market value of all stocks used in the series
Market Value = Number of Shares Outstanding
x Current Market Price
Beginning index value is usually 100, new market values change the value of the index
Automatic adjustment for splits
Weighting depends on market value

9. Value-Weighted Series
where:
Indext = index value on day t
Pt = ending prices for stocks on day t
Qt = number of outstanding shares on day t
Pb = ending price for stocks on base day
Qb = number of outstanding shares on base day

10. Value-Weighted Series
Construction similar to assuming investment in proportion to total market value
Take into account that large market value stocks make up more of the market than do smaller market value stocks
Large market value stocks dominate the impact on index values over time
Also these series tend to be more broad than the DJIA

11. Unweighted Price Indicator Series
All stocks carry equal weight regardless of price or market value
Constructed in a parallel fashion to individuals who select stocks and invest the same dollar amount in each stock
Changes in the index can be reported either in terms of arithmetic or geometric means

12. Style Indexes
Additional indexes have been created that seek to measure the performance of various investment styles or sectors
Size indexes track the performance of large-cap, mid-cap, and small cap stocks
Other indexes track the relative performance of growth and value stocks, perhaps also broken down into sizes

13. Global Equity Indexes
There are stock-market indexes available for most individual foreign markets
These are closely followed within each country
These are difficult to compare due to differences in sample selection, weighting, or computation
In response, some standardized indexes have been developed
FT/S&P Actuaries World Indexes
Morgan Stanley Capital International (MSCI) World Indexes
Dow Jones World Stock Index

14. FT/S&P-Actuaries World Indexes
Track over 2,400 securities in 30 countries
Covers 70% of the total value of all listed companies in each country
Securities included must allow direct holdings of shares by foreign nationals
Index is market-value weighted with a base date of December 31, 1986 = 100
Results are calculated daily and published the following day in the Financial Times
Geographic subgroups are also published

15. MSCI Indexes
Three international, nineteen national, and thirty-eight international industry indexes
Include 1,375 companies listed on stock exchanges in 19 countries with a combined capitalization representing 60 percent of the aggregate market value of the stock exchanges of these countries
All the indexes are market-value weighted

16. Dow Jones World Stock Index
Introduced in January 1993
Includes 28 countries with a total of 2,200 companies worldwide, organized into 120 industry groups
Countries are grouped into 3 regions
Represents over 80% of the combined capitalization of these countries

17. Comparison of World Stock Indexes
Correlations between all of the pairs of broad world indexes are nearly 1.00, indicating that the results with the alternative world stock indexes are quite comparable

18. Bond-Market Indicator Series
Relatively new and not widely published
Growth in fixed-income mutual funds increase need for reliable benchmarks for evaluating performance
Increasing interest in bond index funds, which requires an index to emulate
Many managers have not matched aggregate bond market return

19. Difficulties in Creating a Bond-Market Index
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
Bond prices are affected differently by changing interest rates dependent on maturity, coupon, and market yield
Correctly pricing individual bond issues can be a challenge without current and continuous transaction prices available

20. Bond Market Index Series
Investment-Grade Bond Indexes
Four investment firms maintain indexes for Treasury bonds and other investment grade bonds (rated BBB or higher)
Relationship among these bonds is strong (correlations average 0.95)
High-Yield Bond Indexes
Non investment-grade bonds (rated BB or below)
Several indexes have been created
Relationship among alternative high-yield indexes is weaker than among investment grade indexes

21. Bond Market Index Series
Global Government Bond Market Indexes
Global bond market dominated by government issues
Several indexes created by major investment firms
Indexes have similar characteristics

22. Composite Stock-Bond Indexes
Considers the benefits of diversification with asset allocation across stocks and bonds
Merrill Lynch-Wilshire U.S. Capital Markets Index (ML-WCMI)
Market-value weighted index measures total return performance of the combined U.S. taxable fixed income and equity markets
Brinson Partners Global Security Market Index (GSMI)
Matches a typical U.S. pension fund allocation policy
Close to the theoretical “market portfolio of risky assets” referred to in CAPM

23. Comparison of Indexes Over Time
Correlations among monthly equity price changes
Most differences are attributable to sample differences
High correlations between series based on NYSE firms (about .993)
Lower correlations between NYSE series and AMEX or Nasdaq series (about .903)
Correlations between U.S. series and other countries confirm the wisdom of global investing since values are much lower (averaging .627)

24. Comparison of Indexes Over Time
Correlations among monthly bond indexes
Among investment-grade bonds correlations range from 0.90 to 0.99
Low correlation in global returns to U.S. returns (.07 to .29) support global diversification