ch05 revised ppt investment analysis and portfolio management
- 1. Lecture Presentation Software to accompany Investment Analysis and Portfolio Management by Frank K. Reilly & Keith C. Brown Chapter 5
- 2. Chapter 5 Security-Market Indicator Series Questions to be answered: • What are some major uses of security-market indicator series (indexes)? • What are the major characteristics that cause alternative indexes to differ? • What are the major stock-market indexes in the Pakistan and what are their characteristics?
- 4. Uses of Security-Market Indexes 1. As benchmarks to evaluate the performance of professional money managers 2. To create and monitor an index fund 3. To examine the factors that influence aggregate security price movements 4. For predicting future market movements by technicians 5. As a substitute for the market portfolio of risky assets when calculating the systematic risk of an asset
- 5. Differentiating Factors in Constructing Market Indexes 1. The sample 2. Weighting Sample Members 3. Computational Procedure
- 6. Differentiating Factors in Constructing Market Indexes The sample 1. Size-the sample should be representative of the total population; otherwise, its size will be meaningless. • A large biased sample is no better than a small biased sample. 2. Source-of the sample is important if there are any differences between segments of the population, in which case samples from each segment are required.
- 7. Differentiating Factors in Constructing Market Indexes Weighting of sample members • Four principal weighting schemes are used for security- market indexes: (1) a price-weighted index (2) a market-value weighted index (3) an un-weighted index, or an equal-weighted index, (4) a fundamental weighted index based on some operating variable like sales, earnings, or return on equity.
- 8. Differentiating Factors in Constructing Market Indexes Computational procedure 1. arithmetic average 2. compute an index and have all changes, whether in price or value, reported in terms of the basic index 3. geometric average
- 9. Stock-Market Indicator Series Price Weighted Series • Dow Jones Industrial Average (DJIA)(30 stocks NYSE,USA) • Nikkei-Dow Jones Average (224 stocks, TSE, Japan) Value-Weighted Series • NYSE Composite • S&P 500 Index and more… Unweighted Price Indicator Series • Value Line Averages • Financial Times Ordinary Share Index
- 10. Stock-Market Indicator Series • KSE 100 Index • KSE all shares Index • KSE 30 Index • KMI 30 Index • PSX-KMI all shares Index • Group assignment-prepare detail report on the above indexes(what are they,how are they calculated etc)-submission date 02-05-2025.marks 10
- 11. • Calculations of various indexies
- 12. Price-Weighted Index • A price-weighted index is an arithmetic mean of current stock prices,
- 13. Price-Weighted Index -Dow Jones Industrial Average (DJIA) • Best-known, oldest, most popular series • Price-weighted average of thirty large well- known industrial stocks, leaders in their industry, and listed on NYSE • Total the current price of the 30 stocks and divide by a divisor (adjusted for stock splits and changes in the sample)
- 14. Price-Weighted Index -Dow Jones Industrial Average (DJIA) • A stock split is a corporate action in which a company divides its existing shares into multiple shares to boost the liquidity of the shares, decrease share price, renew investor interest. • number of shares outstanding increases by a specific multiple, the total dollar value of the shares remains the same compared to pre-split amounts. • The most common split ratios are 2-for-1 or 3-for-1, which means that the stockholder will have two or three shares, respectively, for every share held earlier.
- 15. Example-stock split • assume that XYZ Corp. has 20 million shares outstanding and the shares are trading at $100. • Its market cap will be 20 million shares x $100 = $2 billion. • Let's say the company’s board of directors decides to split the stock 2-for-1. • Right after the split takes effect, the number of shares outstanding would double to 40 million, while the share price would be halved to $50, leaving the market cap unchanged at 40 million shares x $50 = $2 billion.
- 16. 1-Price-Weighted Index -Dow Jones Industrial Average (DJIA)
- 17. Example of Change in DJIA Divisor When a Sample Stock Splits After Three-for One Before Split Split by Stock A Prices Prices A 30 10 B 20 20 C 10 10 60 3 = 20 40 X = 20 X = 2 (New Divisor) Exhibit 5.1
- 18. Points to remember • Because the index is price weighted, a high- priced stock carries more weight than a low priced stock. • 10 percent change in a $100 stock ($10) will cause a larger change in the index than a 10 percent change in a $30 stock ($3). • See example in next slide
- 19. Demonstration of the Impact of Differently Priced Shares on a Price-Weighted Indicator Series PERIOD T+ 1 . Period T Case A Case B A 100 110 100 B 50 50 50 C 30 30 33 Sum 180 190 183 Divisor 3 3 3 Average 60 63.3 61 Percentage Change 5.5% 1.7% Exhibit 5.2
- 20. Criticism of the DJIA • Limited to 30 non-randomly selected blue-chip stocks • Does not represent a vast majority of stocks • The divisor needs to be adjusted every time one of the companies in the index has a stock split • Introduces a downward bias by reducing weighting of fastest growing companies whose stock splits
- 21. 2-Value-Weighted Series • A value-weighted index is generated by deriving the initial total market value of all stocks used in • the index Market Value = Number of Shares Outstanding X Current Market Price • Assign an beginning index value (100) and new market values are computed & compared to the base index to determine the percentage change, which in turn is applied to the beginning index value • Automatic adjustment for splits • Weighting depends on market value
- 22. Value-Weighted Series where: Indext = index value on day t Pt = ending prices for stocks on day t Qt = number of outstanding shares on day t Pb = ending price for stocks on base day Qb = number of outstanding shares on base day
- 24. points to remember • In a value-weighted index, the importance of individual stocks in the sample depends on the market value of the stocks. • Therefore, a specified percentage change in the value of a large company has a greater impact than a comparable percentage change for a small company • price changes for large market value stocks in a value-weighted index will dominate changes in the index value over time. Therefore, it is important to be aware of the large-value stocks in the index. • See example in next slide
- 27. 3-Unweighted Price Indicator Series • All stocks carry equal weight regardless of price or market value • May be used by individuals who randomly select stocks and invest the same dollar amount in each stock • Some use arithmetic average of the percent price changes for the stocks in the index
- 29. Unweighted Price Indicator Series • Value Line and the Financial Times Ordinary Share Index compute a geometric mean of the holding period returns and derive the holding period yield from this calculation
- 33. Problem 2 • Given the data in Problem 1, construct an equal- weighted index by assuming $1,000 is invested in each stock. a) What is the percentage change in wealth for this portfolio? b) Compute the percentage of price change for each of the stocks in Problem 1. Compute the arithmetic mean of these percentage changes. Discuss how this answer compares to the answer in Part a. c) Compute the geometric mean of the percentage changes in Part b. Discuss how this result compares to the answer in Part b.
- 34. Style Indexes • Financial service firms such as Dow Jones, Moody’s, Standard & Poor’s, Russell, and Wilshire Associates are generally very fast in responding to changes in investment practices. • One example is the growth in popularity of small-cap stocks following academi research in the 1980s that suggested that over long-term periods, small-cap stocks outperformed large-cap stocks on a risk-adjusted basis.
- 35. • This led to sets of size indexes, including large-cap, mid-cap, small-cap, and micro-cap. • The next innovation was for money managers to concentrate in types of stocks—that is, growth stocks or value stocks. • Eventually, these two factors (size and type) were combined into six major style categories: 1.Small-cap growth 2. Small-cap value 3.Mid-cap growth 4.Mid-cap value 5.Large-cap growth 6. Large-cap value
- 36. • The most recent style indexes are those created to track ethical funds referred to as socially responsible investment (SRI) funds. • These SRI indexes are further broken down by country and include a global ethical stock index.
Editor's Notes
- #3: Imagine a Theme Park Called "Stock Market Land" In this theme park, there are many rides — roller coasters, ferris wheels, carousels, etc. Each ride represents a company's stock — like Apple, Google, or Coca-Cola. Now, every day, these rides go up and down based on how popular they are — just like stock prices! But here's the thing... It's Hard to Track Every Ride! There are thousands of rides (stocks) in Stock Market Land. So how do we know whether the whole park is doing well? That’s where the Stock Market Index comes in What is a Stock Market Index? Think of it like a scoreboard or a thermometer that shows: “Hey! Are most of the rides (stocks) going up today or down?” It’s made by choosing a small group of popular rides (like the top 30 or 500), and checking how they're doing. If most of those are up → the index goes up. If they’re down → the index goes down. A Stock Market Index is like the average mood of the stock market, based on a few key companies. It helps investors know: “Is it a good day or a bad day in the stock market world?”
- #17: The price-weighted series adjusts for a stock split by deriving a new divisor that will ensure that the new value for the series is the same as it would have been without the split. The adjustment for a value-weighted series due to a stock split is automatic. The decrease in stock price is offset by an increase in the number of shares outstanding.
- #25: 20% increase