CHAPTER 6 THE USES AND CALCULATION OF MARKET INDEXES

chapter 6 the uses and calculation of market indexes 1. market indexes represent an average cost or price for purchasing a bundle of stocks

CHAPTER 6 THE USES AND CALCULATION OF MARKET INDEXES
1. Market indexes represent an average cost or price for purchasing a
bundle of stocks. Market indexes are commonly used by security
analysts as a bench mark of comparison for mutual funds.
2. Indexes can be price weighted or value weighted.
3. Paasche index uses the current year basket of goods while Laspeyres
uses the base year basket of goods. The advantage of the Paasche index
is Chat because it uses the current basket of goods, it may be more
representative of current costs.
4. The Dow Jones Industrial Average is an Index of 30 large industrial
firms. The DJIA Is a price weighted index.
5. The S&P 500 is made up Of 500 stocks which trade on the NYSE. It
includes 400 industrials, 40 utilities, 40 financials and 20
transporations. Because it includes more stocks from a broader number
of industries, the S&P 500 is usually considered a better measure of
market e than the DJIA.
6.
Geometric Average =
Arithmetic Average =
The geometric average tends to understate the central tendency
relative to arithmetic average.
7. Because the market portfolio should consist of all assets,
including stocks, bonds and real estate, Roll questions the adequacy
of using market indexes as proxies of the market portfolio. In a
series of papers, Roll shows mathematically and empirically that tests
of asset pricing models are inappropriate when a proxy of the market
portfolio is used.
8. The advantage of using a narrowly focused index like the DJIA is
that if the 30 stocks in DJ1A provide a good representation of the
stock market, then there is no need to use a broader index. Using a
broader based index like the Wilshire 5000 may be preferred to the
DJIA because it gives more weight to a wider range of industries and
to smaller, less frequently traded stock.
9. S&P 500
S&P 100
DJIA
Wilshire 5000
DJ Bond
Solomon Mortgage Backed Bond Index
Merrill Lynch Corpora Bond Index
These indexes provide information on the performance of the assets
that the index is meant to mimic.