MIRPUR UNIVERSITY OF SCIENCE AND TECHNOLOGY

(MUST), AZAD KASHMIR

MUST BUSINESS SCHOOL

 Advance Portfolio Management
MS-759

Lecture 06: Security-Market Indexes

Dr. Zafar Iqbal

Email: Z_iqbalch@yahoo.com
 Lecture 06

Security-Market
Security-MarketIndexes
Indexes
 Stock market index

An index is a method to track the

performance of some group of assets
in a standardized
way. Indexes typically measure the
performance of a basket of securities
intended to replicate a certain area of
the market.
Uses of Security-Market Indexes
• As benchmarks to evaluate the performance of
professional money managers
• To create and monitor an index fund
• To measure market rates of return in economic
studies
• For predicting future market movements by
technicians
• As a substitute for the market portfolio of risky
assets when calculating the systematic risk of
an asset
 Differentiating Factors in
Constructing Market Indexes
Weighting of sample members
• Price-weighted series
• Value-weighted series
• Unweighted (equally weighted) series
 Differentiating Factors in
Constructing Market Indexes
Computational procedure
• arithmetic average
• compute an index and have all changes,
whether in price or value, reported in
terms of the basic index
• geometric average
 Stock-Market Indicator Series
Price Weighted Series
• Dow Jones Industrial Average (DJIA)
• Nikkei-Dow Jones Average
Value-Weighted Series
• NYSE Composite
• S&P 500 Index and more…
Unweighted Price Indicator Series
• Value Line Averages
• Financial Times Ordinary Share Index
 Price-weighted series

A price-weighted series is an arithmetic average of current prices,

which means that index movements are influenced by the differential
prices of the components.
 Dow Jones Industrial Average
(DJIA)
• Best-known, oldest, most popular series
• 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
and changes in the sample)
Example of Change in DJIA Divisor
When a Sample Stock Splits
After Three-for One
Exhibit 5.1
Before Split Split by Stock A
Prices Prices
A 30 10
B 20 20
C 10 10
60 3 = 20 40 X = 20
X = 2 (New Divisor)
Demonstration of the Impact of Differently
Priced Shares on a Price-Weighted
Indicator Series Exhibit 5.2
PERIOD T+ 1 .

Period T Case A Case B

A 100 110 100
B 50 50 50
C 30 30 33
Sum 180 190 183
Divisor 3 3 3
Average 60 63.3 61
Percentage Change 5.5% 1.7%
 Value-Weighted Series
• Derive the initial total market value of all stocks
used in the series
Market Value = Number of Shares Outstanding
X Current Market Price
• Assign an beginning index value (100) and new
market values are compared to the base index
• Automatic adjustment for splits
• Weighting depends on market value
 Value-Weighted Series

Index t 
 PQt t
 Beginning Index Value
PQ b b

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
 Index base day value= 1000
No. of
Price (t) 12 Price (b) 11 Outstandin Market
Stock
sept 2020 sept 2020 g shares Value (t)

A 15 10 1000 15000

B 20 20 1000 20000

C 15 15 1000 15000

D 10 10 1000 10000

ΣP×Q 60000
• =(55000/55000)*1000
• Day 1 or base day index=1*1000=1000
Point
• Day 2=(60000/55000)*1000
• Day 2=1.0909*1000
• =1090.90 points
• % change= 1090.90/1000-1=9%
Unweighted Price Indicator Series
• 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
Unweighted Price Indicator Series
• Value Line and the Financial Times
Ordinary Share Index compute a geometric
mean of the holding period returns and
derive the holding period yield from this
calculation
 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
computational procedure
• Groups have computed country indexes