Chapter 9 Lecture Video Notes Market Averages Indexes they are commonly spoken together because they fundamentally do the same thing but they are calculated in different ways A group of pre selected securities usually chosen for some shared characteristics Practical uses o General market movement o Forecasting o Benchmarks How to use o Appropriate index They give us an idea how the market in general is performing so we can determine how our individual company or investment is performing If my goal is to hold a computer company I should measure the performance of my individual computer company against an index for computer companies However if I just buy Apple I would want to measure it against a market index such as SEP 500 and the Dow Jones Average There is a lot of volatility in the indexes It must be the exact time period Measure them from the same day to the same day o Time period o Compare by changes not amount Dow Jones Averages o Tracks general behavior of component firms o Equally weighted average changes in higher priced components have greater impact on average Stock 1 50 10 5 points Stock 2 200 10 20 points If stock 1 is priced at 50 and rises at 10 and stock 2 is priced at 200 and rises at 10 stock 2 will have a greater impact on the average because of its higher price o Divisor maintains comparative relationship over time Its sole purpose is to maintain the validity of time comparisons made within a single Dow average It does not make numerical comparisons between Dow averages or other indexes valid Percentage changes are used o Multiple Dow Jones Averages high quality DJ Industrial Average DJIA 30 market value broad public ownership These would be the largest companies in the appropriate industries The intention of the Dow is to give a broad overview of what is happening in the economy DJ Transportation Average 20 Consists of companies involved in trucking FedEx planes railroads anything that involves the movement of things from point A to point B DJ Utility Average 15 DJ Composite Average 30 20 15 65 o Transportation averages are usually used as leading indicators For example during Christmas time people are starting to send presents to each other and companies start moving inventory from manufacturers to distribution houses to the stores Increase in transportation averages could mean the economy is picking up S P 500 Index o Standard Poor s firms that selects index components 500 major firms across sectors S P 500 is broader than the DJIA All U S firms but with global exposure Almost 50 of the production sales and profits of U S firms come from overseas business The amount paid in foreign tax is much larger than the amount paid in U S tax o Considers the market value of constituent firms Value weighted MV closing price x of shares The size of the company is taken into consideration Recall The DJIA does not take into consideration the size of company All types of Indexes o Indexes continually revised throughout the day this is because we now have computers that can track many companies throughout the stock market Standard cite is closing price the last price of the day Change is relative to previous day s closing price o Nasdaq Composite Index 3 000 U S and International firms High concentration of technical and growth firms o The Market is generally referring to the DJIA or the S P 500 o Mixed Market When the DJIA and the S P 500 and Nasdaq are moving in different directions One or two are up and the others are down o Most asset types tend to move in the same direction Most stocks on a good day will move up Individual firm sensitivity to the market varies o Bond Indexes o MSCI Morgan Stanley Country Indexes Chapter 9 Textbook Outline Pages 182 188 Understanding Market Averages and Indexes A widely used way to assess the behavior of securities markets is to study the performance of market averages and indexes These measures allow you to conveniently 1 Gauge general market conditions 2 Compare your portfolio s performance to that of a large diversified market portfolio 3 Study market cycles trends and behaviors in order to forecast future market behavior Stock Market Averages and Indexes Stock market averages and indexes measure the general behavior for stock prices over time o Averages reflect the arithmetic price behavior of a representative group of stocks at a given point in time o Indexes measure the current price behavior of a representative group of stock in relation to a base value set at an earlier point in time o Both these measures capture the general mood of the market o Both indexes and averages can be found quoted daily on financial websites and Dow Jones Averages Dow Jones Company publisher of the Wall Street Journal news prepares four stock averages o Dow Jones Industrial Average DJIA made up of 30 stocks selected for total market value and broad public ownership The group consists of high quality stocks whose behaviors are believed to reflect overall market activity o The value of the DJIA is calculated each business day by substituting the closing share prices of each of the 30 stocks in the DJIA into the following equation Closing share price of stock 1 Closing share of stock 30 DJIA DJIA divisor o o The purpose of the divisor is to adjust for any stock splits company changes or other events that have occurred over time The divisor makes it possible to use the DJIA to make time series comparisons o Higher priced stocks tend to affect the index more than do lower priced stocks because a 5 change in a 100 stock has more impact on the index than a 5 change in a 50 stock o The actual value of DJIA is meaningful only when compared to earlier values o Dow Jones Transportation Average based on 20 stocks including railroads airlines freight forwarders and mixed transportation companies o Dow Jones Utilities Average computed using 15 public utility stocks o Dow Jones 65 Stock Composite Average made up of 30 industrials 20 transportations and 15 utilities o Dow Jones also publishes the DJ U S Total Stock Market Index a market weighted index which means that companies with large total market values have the most effect on the index s movement Standard and Poor s Indexes They publish six major common stock indexes They are calculated each business day by substituting the closing market value of each stock closing price x number of shares outstanding into the following equation Sum of Current closing market value of all stocks S P Index Sum of base period
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