Feb 5 2013

LOS 47.a: Describe a security market index

A security market index is used to represent the performance of an asset class, security market, or segment of a market. They are usually created as portfolios of individual securities, which are referred to as the constituent securities of the index. 

LOS 47.b: Calculate and interpret the value, price return, and total return of an index.

Price Index : A rate of return that is calculated based on a price index is referred to as 

                     a price return

Return Index: A rate of return that is calculated based on a return index is called a 

                       total  return

LOS 47.c:

target market

LOS 47.d:

Price-weighted index 

• an arithmetic average of the prices of the securities included in the index
• advantage of a price-weighted index is that its computation is simple
• higher priced stocks have more weight in the calculation of a price-weighted index
• Two major price-weighted indexes are the Dow Jones Industrial Average (DJIA) and the Nikkei Dow Jones Stock Average.

Equal-weighted index

• the arithmetic average return of the index stocks and, for a given time period, would be matched by the returns on a portfolio that had equal dollar amounts invested in each index stock
• The Value Line Composite Average and the Financial Times Ordinary Share Index are well-known examples of equal-weighted indexes

Market capitalization-weighted index

• A firm's market float is the total value of the shares that are actually available to the investing public and excludes the value of shares held by controlling stockholders because they are unlikely to sell their shares
• Sometimes the market float calculation excludes shares that are not available to foreign buyers and is then referred to as the free float

Float-adjusted market capitalization-weighted index

• The advantage of market capitalization-weighted indexes of either type is that index
  security weights represent proportions of total market value
• that stocks that are possibly overvalued are given disproportionately high weights in the index and stocks that are possibly undervalued are given disproportionately low weights
• The Standard and Poor's 500 (S&P 500) Index Composite is an example of a market
  capitalization-weighted index.

Fundamental weighting

LOS 4 7 .e

Price weighted Index = sum of stock prices / number of stocks in index adjusted for splits

LOS 47.f:

Rebalancing

reconstitution

LOS 47.g:

Security market indexes have several uses:

• Reflection of market sentiment
• Benchmark of manager performance
• Measure of market return and risk.
• Measure of beta and risk-adjusted return
• Model portfolio for index funds

 LOS 47.h:

Investors can use a variety of equity market indexes. These equity indexes can be
classified as follows:

• Broad market index
• Multi-market index
• Multi-market index with fundamental weighting
• Sector index
• Style index

LOS 4 7 .i:

types of fixed-income indices

• Large universe of securities
• Dealer markets and infrequent trading

LOS 47.j:

Indices representing alternative investments.

Three of the most widely held alternative assets are commodities, real estate,
and hedge funds

Commodity indexes

The issues in commodity indexes relevant for investors are as follows

• Weighting method.
• Futures vs. actual.

Real estate