Lecture 14: Indexes P2

Investment Analysis Indexes and Index Funds – Part 2

Indexes

Value-Weighted Index:

• Calculates total market value through market capitalization.

• Starts with a benchmark of 100, adjusts for stock splits.

• Weighting based on market values, larger companies impact the index more.

• Calculation Formula:[ I_t = \frac{\sum (P_{i,t} \times Q_{i,t})}{\sum (P_{i,t-1} \times Q_{i,t-1})} \times BBVB ](Where [ t ] is the index value on day [ t ])

• Example: A, B, C stocks show growth from $200M to $242M, leading to a new index value of 121.

Understanding Price-Weighted Indexes:

• Accounts for stock price changes and requires new divisor calculations post-split.

Specific Indexes

S&P 500:

• Established in 1957, includes 500 stocks representing the U.S. economy.

• Stocks must be above $14 billion market cap.

• Top 10 stocks account for 30% of returns.

Dividend Considerations:

• Differentiates between indices that include dividends (S&P 500 Total Return Index) vs. those that don’t.

• Average return (1990-2024): 7.96% excluding dividends, 10.26% including.

• Reinvesting dividends significantly increases portfolio growth.

NASDAQ Index:

• Focused on technology companies, includes foreign firms, using a unique limiting weighting system.

Unweighted vs. Weighted Indices:

• Unweighted indices give equal weight, allowing for a broader view.

• Value-weighted indices capture the impact of market capitalizations.

Advanced Calculation Techniques:

• Geometric mean yields lower results than arithmetic mean due to compounding effects in performance assessments.