CHAPTER ELEVEN
MARKET INDEXES
© 2001 South-Western College Publishing
Outline

Index Construction
Price Weighting
 Equal Weighting
 Capitalization Weighting


Popular Indexes
Stock Indexes
 Fixed Income Indexes
 International Indexes

2
Index Construction: Price Weighting

A price-weighted index is composed
of a single share of each of the
index components, regardless of the
price of the share or the size of the
underlying company.

For example, the shares of 30 industrial
companies make up the Dow Jones Industrial
Average (DJIA).

To account for artificial price changes due to
stock splits, an index divisor is made
use of.
3
New Divisor after a Stock Split
Day One
Day Two
Company A
$30
3-for-1 split
$10
Company B
20
20
Company C
10
10
Total $60
$40
Apparent change in index = - 33.3%
Divisor
3.0
60/3.0 = $20
2.0
$40/2.0 = $20
Apparent change = 0.0%
The divisor maintains economic integrity.
4
Index Construction: Equal Weighting


An equal-weighted index reflects the
performance associated with the
selection of a particular security by
chance. It is measured by price
change rather than by price alone.
Theoretically, equal weighting is preferable to
price weighting.
5
Construction of an Equal-Weighted Index
Initial Subsequent
Weighted
Security Price
Price
Return Return
A
B
C
D
E
Index
$ 10
20
35
27
109
$ 10 1 2
21 3 8
33
28 1 2
114
100.00
103.26
5.00 % 1.00 %
6.875
1.375
-5.71
-1.143
5.56
1.111
4.587
0.917
3.260%
6
Index Construction: Capitalization Weighting


In capitalization weighting, also
called value weighting, the share
price is multiplied by the number of
outstanding shares.
The total is then compared to some arbitrary
starting value (base value).
7
Construction of a Value-Weighted Index
Company Shares Outstanding
A
B
C
Price
Shares x Price
200,000,000
$30
$6,000,000,000
50,000,000
20
1,000,000,000
100,000,000
10
1,000,000,000
Base Value  $8,000,000,000
Initial value of the index = $8,000,000,000 = 100.00
$80,000,000
Suppose that later, shares x price sum up to $8,200,000,000.
Then the new value of the index = $8,200,000,000 = 102.50
$80,000,000
8
Popular Indexes: Stock Indexes
Dow Jones Averages

The four primary averages are the industrial
average (30 large blue chip companies), the
transportation average (20 transportation
companies), the utility average (15 public
utility stocks), and the Dow Jones composite
(all the 65 stocks in the DJIA, DJTA, and
DJUA).

Price-weighted.
9
Popular Indexes: Stock Indexes
Standard & Poor’s Indexes

The main indexes are the S&P 500 Composite
(500 NYSE-traded securities), S&P Mid Cap
400 (400 mid-capitalization securities), S&P
Small Cap 600 (600 small-cap stocks), and the
S&P Super Composite 1500 (500 + 400 + 600).

Value-weighted.
10
Popular Indexes: Stock Indexes
Others

The NYSE Composite is an average of all the
stocks listed on the New York Stock
Exchange.

The Russell 3000 index is a mix of both largeand small-capitalization stocks and, to many
portfolio managers, a better representation of
the broad market.
11
Popular Indexes: Fixed Income Indexes

More than 400 indexes measure fixed income
securities.

Examples include :
- Dow Jones 20 Bond Index
- S&P Municipal Bond Index
- S&P U.S. Government Bond Index
- Salomon Brothers Corporate Bond Index
12
Popular Indexes: International Indexes

European indexes
- United Kingdom: FT-SE 100
- Germany: DAX 30
- France: CAC-40
- Italy: MIB 30

Asia and the Pacific Rim
- Japan: Nikkei 225, TOPIX, Nikkei 300
- Australia: All Ordinaries
- Hong Kong: Hang Seng
13
Review

Index Construction
Price Weighting
 Equal Weighting
 Capitalization Weighting


Popular Indexes
Stock Indexes
 Fixed Income Indexes
 International Indexes

14