2. Market Index V.

Shankar

 Index

gives an idea on how the market is

faring Product of innovation creation of index funds and index derivatives Facilitates hedging of a portfolio of underlying assets Enables forecasting of future through speculation
V. Shankar/20.07.08

 Measures

change in a set of values over a period of time A good stock market index should capture the overall market behavior Index should be well diversified, yet highly liquid Uses of market index

Barometer for market behavior Benchmark for portfolio performance Underlying for index options and futures Allows passive fund management by index funds
V. Shankar/20.07.08

 Reflect

the changing expectations of the stock market about future dividends of the corporate sector Stock price movement influenced by:
News about the company (acquisition/takeover, new

product launch, new client/order acquisition , modernization program, etc.) News about the country (budget announcements, etc.)
Function

of index is to capture news about the country accurately after eliminating stock-specific variations

V. Shankar/20.07.08

good index is a trade-off between diversification and liquidity Going from 10 stocks to 20 - sharp reduction in risk. Going from 50 stocks to 100 - very little reduction. Going beyond 100 almost zero reduction. Critical issue is choice of stock for inclusion in the index illiquid stock actually contaminates the index
V. Shankar/20.07.08

 Price-weighted

index

Each stock in the index is assigned a weight in

proportion to its stock price E.g. Dow Jones Industrial Average

Market

capitalization-weighted index

Each stock in the index affects the index value in

proportion to the market value of all its outstanding shares Free float method is a refinement
E.g. S&P500, FTSE100, S&P CNX Nifty, Sensex
V. Shankar/20.07.08

 Index

= Current MC --------------- x Base value Base MC

Where Current MC = Sum of (current MP x outstanding shares) of all index securities Base MC = Sum of (MP x issue size) of all index securities in base year
V. Shankar/20.07.08

Should capture behavior of portfolios

Should reflect behavior of overall market as well as of

diverse portfolios Diversification of index basket to minimize individual stock/industry risk

Should include liquid stocks

Trading frequency, trading volume and impact cost are

attributes of liquidity

Should be managed professionally

Periodic review to determine need for change in index

basket Small changes in composition so as not to alter the fundamental characteristic of the index Time series date should be available
V. Shankar/20.07.08

Barometer of the economy / market Index derivatives

Derivative contracts having index as the underlying (e.g. index futures and

index options)

Index funds
A fund that attempts to replicate index returns Investment in index stocks in same proportion as in the index

Exchange Traded Funds

Introduced in USA in 1993 Over US$ 500 billion invested in more than 500 ETFs About 60% of trading on Amex is from ETFs Spiders based on S&P500,

Cubes based on Nasdaq100, iSHARES based on MSCI and Tracks based on Hang Seng Provide exposure to index/basket of securities by trading as a single stock Can be bought and sold at prices usually close to intraday NAV of the scheme Nifty BeEs based on S&P CNX Nifty launched in December 2001 by Benchmark Mutual Fund

V. Shankar/20.07.08

V. Shankar/20.07.08