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8/12/2019 Security Market Indicator Series.st
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Chapter 5
Innovative Financial Instruments
Dr. A. DeMaskey
Security-Market Indicator
Series
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Uses ofSecurity-Market IndexesAs benchmarks to judge portfolio
performance
To develop an index portfolioTo examine factors that influence
aggregate security price movement
To predict future price movementTo compute systematic risk of an asset
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Differentiating Factors inConstructing Market Indexes
The samplesize
breadth
sourceWeighting sample
membersprice-weighted series
value-weighted series
unweighted (equallyweighted) series
Computationalprocedurearithmetic average
indexedgeometric average
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Stock-Market Indicator
SeriesPrice-Weighted SeriesDow Jones Industrial Average (DJIA)
Nikkei Average
Value-Weighted SeriesNYSE Composite
S&P 500 Index
AMEX Index
and more.
Unweighted IndexValue Line
Financial Times Ordinary Share Index
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Dow Jones Industrial
Average (DJIA)
Best-known, oldest, most popular series
Price-weighted average of thirty largewell-known industrial stocks, leaders intheir industry, and listed on NYSE
Total the current price of the 30 stocksand divide by a divisor (adjusted forstock splits and changes in the sample)
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Example of Change in DJIA Divisor
When a Sample Stock Splits
After Three-for OneBefore Split Split by Stock A
Prices Prices
A 10 10
B 15 15
C 20 1045 3 = 15 35 X = 15
X = 2.33 (New Divisor)
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Demonstration of the Impact ofDifferently Priced Shares on a Price-Weighted Indicator Series
PERIOD T+ 1 .
Period T Case A Case B
A 100 110 100B 50 50 50
C 30 30 33
Sum 180 190 183Divisor 3 3 3
Average 60 63.3 61
Percentage Change 5.5% 1.7%
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Criticism of the DJIA
Sample used is limited
30 non-randomly selected blue-chip stocksare not representative of the 1800 NYSE
listed stocksPrice-weighted series
Stock split results in less weighting for
sample stockIntroduces a downward bias in DJIA by
reducing weighting of fastest growingcompanies whose stock splits
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Nikkei-Dow Jones Average
Arithmetic average of prices for 225stocks on the First Section of the Tokyo
Stock Exchange (TSE)Best-known series in Japan
Price-weighted series formulated by
Dow Jones and CompanyThe 225 stocks represent 15 percent of
all stocks on the First Section
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Value-Weighted Series
Derive the initial total market value of allstocks used in the seriesMarket Value = Number of Shares Outstanding
x Current Market Price
Assign a beginning index value (100)
New market values are compared to the
base index
Automatic adjustment for splits
Weighting depends on market value
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Value-Weighted Series:Illustration
Consider the following three stocks:
Stock Price No. of Shares Value(Million) ($Million)
June 30, 2000:
A 20 2.0 40
B 40 2.5 100
C 60 1.0 60
200
Let this $200 million have an index value of 100.
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Value-Weighted Series:Illustration Continued
Stock Price No. of Shares Value(Million) ($Million)
June 30, 2001:
A 24 2.0 48
B 30 5.0 150
C 60 1.0 60
258
(Note: Stock B split 2-for-1 during the year.)
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Global Equity Indexes
There are stock-market indexesavailable for most individual foreignmarkets.
These are closely followed within eachcountry.
These are difficult to compare due todifferences in sample selection,weighting, or computational procedure.
Groups have computed countryindexes.
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FT/S&P-Actuaries WorldIndexes
Jointly compiled by The Financial TimesLimited, Goldman Sachs & Company, and
Standard & Poors in conjunction with theInstitute of Actuaries and the Faculty of
Actuaries.
Measures 2,461 securities in 30 countries.Covers 70% of the total value of all listed
companies in each country.
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FT/S&P-Actuaries WorldIndexes
Includes actively traded medium andsmall corporations along with major
international equities.Securities included must allow direct
holdings of shares by foreign nationals.
Index is market-value weighted with abase date of December 31, 1986 = 100.
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FT/S&P-Actuaries WorldIndexes
Index results are reported in U.S. dollars,U.K. pound sterling, Japanese yen,
German mark, and the local currency ofthe country included.
Results are calculated daily after the New
York markets close and published thefollowing day in the Financial Times.
Geographic subgroups are also published.
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Morgan Stanley CapitalInternational (MSCI) Indexes
Three international, nineteen national, andthirty-eight international industry indexes
1,375 companies listed on stock exchanges in
19 countries with a combined capitalizationrepresenting
60% of the aggregate market value of the stockexchanges of these countries
All the indexes are market-value weighted
Reporting is in U.S. dollars and the countryslocal currency
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Morgan Stanley CapitalInternational (MSCI) Indexes
Also provides:price to book value (P/BV) ratio
price to cash earnings (earnings plus depreciation)
(P/CE) ratioprice to earnings (P/E) ratio
dividend yield (YLD)
The Morgan Stanley group index for Europe,
Australia, and the Far East (EAFE) is used asthe basis for futures and options contracts
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Dow Jones World Stock
Index
Introduced in January 1993
2,200 companies worldwide
Organized into 120 industry groups
Includes 33 countriesCountries are grouped into 3 regions
Represents over 80% of the combinedcapitalization of these countries
Country indexes are computed in localcurrency, U.S. dollars, British pound, Germanmark, and Japanese yen
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Comparison ofWorld Stock Indexes
Correlations between the three seriessince December 31, 1991, indicate the
results with the alternative world stockindexes are quite comparable.
U.S. Dollars
FT - MS: .998FT - DJ: .997
MS - DJ: .996
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Bond-Market Indicator
Series
Relatively new and not widely published
Growth in fixed-income mutual funds
increase need for reliable benchmarksfor evaluating performance
Many managers have not matched
aggregate bond market returnincreasing interest in bond index funds
requires an index to emulate
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Difficulties in Creating and Computing
Bond-Market Indicator Series
Range of bond quality varies from U.S. Treasurysecurities to bonds in default
Bond market changes constantly with new issues,maturities, calls, and sinking funds
Bond prices are affected by duration, which isdependent on maturity, coupon, and market yield
Correctly pricing individual bond issues withoutcurrent and continuous transaction pricesavailable
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Investment-Grade BondIndexes
Four investment firms maintain indexesfor Treasury bonds and other investment
grade (rated BBB or higher) bonds.Relationship among these bonds is strong
(correlations average 0.95).
Returns for all these bonds are driven byaggregate interest rates - shifts in thegovernment yield curve.
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High-Yield Bond Indexes
Non investment-grade bonds
Four investment firms and two
academicians created indexesRelationship among alternative high-
yield bond indexes is weaker than
among investment grade indexes.Merrill Lynch Convertible Securities
Indexes
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Global Government BondMarket Indexes
Global bond market dominated bygovernment issues
Several indexes created by majorinvestment firms:Measure total rates of return
Use market-value weighting
Use trader pricing
But sample sizes differ as do numbers ofcountries included
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Global Government Bond Market
Indexes: Analysis of Performance
Differences affect long-term risk-returnperformance
Low correlation among several countriesis similar to stocks
Significant exchange rate effect on
volatility and correlations
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Composite Stock-BondIndexes
A composite series measures theperformance of all securities in a given
country.Allows examination of benefits of
diversification with a combination of asset
classes such as stocks and bonds
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Merrill Lynch-Wilshire U.S.Capital Markets Index (ML-WCMI)
Market-value weighted index
Measures total return performance of
the combined U.S. taxable fixed incomeand equity markets
Combination of Merrill-Lynch fixed-
income indexes and the Wilshire 5000common-stock index
Tracks over 10,000 stocks and bonds
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Brinson Partners GlobalSecurity Market Index (GSMI)
Includes:U.S. stocks and bonds
Non-U.S. equities
Non-dollar bonds
Allocation to cash
Matches a typical U.S. pension fund
allocation policyClose to the theoretical market portfolio
of risky assets referred to in CAPM
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Comparison of Indexes Over
Time
Correlations Among Monthly EquityPrice Changes
Most differences are attributable to sampledifferences
Different segments of U.S. stock market orfrom different countries
Lower correlations between NYSE seriesand AMEX series or NASDAQ index thanbetween NYSE alternative series (S&P 500and NYSE composite)
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Correlations Among Monthly BondIndexes
Among investment-grade bonds correlationsrange from 0.90 to 0.99
Interest rates differ by risk premiums
Rates of return are determined by systematic
interest rate variables
Low correlation in global returns to U.S.returns support global diversification
Comparison of Indexes Over
Time
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Mean Annual Stock Price Changes
Expect differences among price changesand measures of risk for various series dueto the different samples.
NYSE series have lower rates of return and riskmeasure than AMEX and OTC series, asexpected.
Canadian results had higher average returnsthan NYSE and lower risk than NASDAQ.
Japanese markets had lower returns andslightly lower volatility than U.S. market.
Comparison of Indexes Over
Time
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Mean Annual Stock Price Changes(continued)
United Kingdom (FT All-Share) had higher returnsthan NYSE indexes, but much larger variability
Japanese markets experienced lower returns andslightly lower volatility than the U.S. markets
Low correlation between Japanese marketwith alternative U.S. stock-market indexes.
Japan could be a prime source of diversification
Comparison of Indexes Over
Time
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Annual Bond Rates of Return
Total rates of return for bond-market indexes
cannot be directly compared to stockpercentage price change results
Expect difference in level of return due todifferential risk premiums
Results confirm expectations
Comparison of Indexes Over
Time
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The Internet:Investments Online
www.bloomberg.com
www.stockmaster.com
www.asx.com.au
www.bolsamadrid.es
www.tse.com
www.nikko.co.jp:80/SEC/index_e.html
www.exchange.de/realtime/dax_d.html
http://www.bloomberg.com/http://www.stockmaster.com/http://www.asx.com.au/http://www.bolsamadrid.es/http://www.tse.com/http://www.nikko.co.jp/SEC/index_e.htmlhttp://www.exchange.de/realtime/dax_d.htmlhttp://www.exchange.de/realtime/dax_d.htmlhttp://www.nikko.co.jp/SEC/index_e.htmlhttp://www.tse.com/http://www.bolsamadrid.es/http://www.asx.com.au/http://www.stockmaster.com/http://www.bloomberg.com/