Stock market

From Wikipedia, the free encyclopedia

It has been suggested that this article or section be merged with Stock exchange. (Discuss) Proposed
since June 2010.

Financial markets

Public market

Exchange Securities Bond market Fixed income Corporate bond Government bond Municipal bond Bond valuation High-yield debt Stock market Stock Preferred stock Common stock Registered share Voting share Stock exchange Derivatives market Securitization Hybrid security Credit derivative Futures exchange

OTC, non organized

Spot market Forwards Swaps Options Foreign exchange Exchange rate Currency

Other markets Money market Reinsurance market Commodity market Real estate market Practical trading Participants Clearing house Financial regulation

Finance series Banks and banking Corporate finance Personal finance Public finance vde

A stock market or equity market is a public entity (a loose network of economic transactions, not a physical facility or discrete entity) for the trading of company stock(shares) and derivatives at an agreed price; these are securities listed on a stock exchange as well as those only traded privately. The size of the world stock market was estimated at about $36.6 trillion at the start of October 2008.[1] The total world derivatives market has been estimated at about $791 trillion face or nominal value,[2] 11 times the size of the entire world economy.[3] The value of the derivatives market, because it is stated in terms of notional values, cannot be directly compared to a stock or a fixed income security, which traditionally refers to an actual value. Moreover, the vast majority of derivatives 'cancel' each other out (i.e., a derivative 'bet' on an event occurring is offset by a comparable derivative 'bet' on the event not occurring). Many such relatively illiquid securities are valued asmarked to model, rather than an actual market price.

The stocks are listed and traded on stock exchanges which are entities of a corporation or mutual organization specialized in the business of bringing buyers and sellers of the organizations to a listing of stocks and securities together. The largest stock market in the United States, by market capitalization, is the New York Stock Exchange(NYSE). In Canada, the largest stock market is the Toronto Stock Exchange. Major European examples of stock exchanges include the Amsterdam Stock Exchange,London Stock Exchange, Paris Bourse, and the Deutsche Brse (Frankfurt Stock Exchange). In Africa, examples include Nigerian Stock Exchange, JSE Limited, etc. Asian examples include the Singapore Exchange, the Tokyo Stock Exchange, the Hong Kong Stock Exchange, the Shanghai Stock Exchange, and the Bombay Stock Exchange. In Latin America, there are such exchanges as the BM&F Bovespa and the BMV.
Contents
[hide]

1 Trading 2 Market participants 3 History 4 Importance of stock market

o o o o o o

4.1 Function and purpose 4.2 Relation of the stock market to the modern financial system 4.3 United States stock market returns 4.4 The behavior of the stock market 4.5 Irrational behavior 4.6 Crashes

5 Stock market index 6 Derivative instruments 7 Leveraged strategies

o o

7.1 Short selling 7.2 Margin buying

8 New issuance 9 Investment strategies 10 Taxation 11 See also 12 References 13 Further reading 14 External links

[edit]Trading

The London Stock Exchange

Participants in the stock market range from small individual stock investors to large hedge fund traders, who can be based anywhere. Their orders usually end up with aprofessional at a stock exchange, who executes the order of buying or selling. Some exchanges are physical locations where transactions are carried out on a trading floor, by a method known as open outcry. This type of auction is used in stock exchanges and commodity exchanges where traders may enter "verbal" bids and offers simultaneously. The other type of stock exchange is a virtual kind, composed of a network of computers where trades are made electronically via traders. Actual trades are based on an auction market model where a potential buyer bids a specific price for a stock and a potential seller asks a specific price for the stock. (Buying or selling at market means you will accept any ask price or bid price for the stock, respectively.) When the bid and ask prices match, a sale takes place, on a first-come-first-served basis if there are multiple bidders or askers at a given price. The purpose of a stock exchange is to facilitate the exchange of securities between buyers and sellers, thus providing a marketplace (virtual or real). The exchanges provide real-time trading information on the listed securities, facilitating price discovery.

The New York Stock Exchange

The New York Stock Exchange is a physical exchange, also referred to as a listed exchange only stocks listed with the exchange may be traded. Orders enter by way of exchange members and flow down to a floor broker, who goes to the floor trading post specialist for that stock to trade the order. The specialist's job is to match buy and sell orders using open outcry. If a spread exists, no trade immediately takes

placein this case the specialist should use his/her own resources (money or stock) to close the difference after his/her judged time. Once a trade has been made the details are reported on the "tape" and sent back to the brokerage firm, which then notifies the investor who placed the order. Although there is a significant amount of human contact in this process, computers play an important role, especially for so-called "program trading". The NASDAQ is a virtual listed exchange, where all of the trading is done over a computer network. The process is similar to the New York Stock Exchange. However, buyers and sellers are electronically matched. One or more NASDAQ market makers will always provide a bid and ask price at which they will always purchase or sell 'their' stock.[4] The Paris Bourse, now part of Euronext, is an order-driven, electronic stock exchange. It was automated in the late 1980s. Prior to the 1980s, it consisted of an open outcry exchange. Stockbrokers met on the trading floor or the Palais Brongniart. In 1986, the CATS trading system was introduced, and the order matching process was fully automated. From time to time, active trading (especially in large blocks of securities) have moved away from the 'active' exchanges. Securities firms, led by UBS AG, Goldman Sachs Group Inc. and Credit Suisse Group, already steer 12 percent of U.S. security trades away from the exchanges to their internal systems. That share probably will increase to 18 percent by 2010 as more investment banks bypass the NYSE and NASDAQ and pair buyers and sellers of securities themselves, according to data compiled by Boston-based Aite Group LLC, a brokerage-industry consultant.[5] Now that computers have eliminated the need for trading floors like the Big Board's, the balance of power in equity markets is shifting. By bringing more orders in-house, where clients can move big blocks of stock anonymously, brokers pay the exchanges less in fees and capture a bigger share of the $11 billion a year that institutional investors pay in trading commissions as well as the surplus of the century had taken place.[citation needed].

[edit]Market

participants

A few decades ago, worldwide, buyers and sellers were individual investors, such as wealthy businessmen, usually with long family histories to particular corporations. Over time, markets have become more "institutionalized"; buyers and sellers are largely institutions (e.g., pension funds, insurance companies,mutual funds, index funds, exchange-traded funds, hedge funds, investor groups, banks and various other financial institutions). The rise of the institutional investor has brought with it some improvements in market operations. Thus, the government was responsible for "fixed" (and exorbitant) fees being markedly reduced for the 'small' investor, but only after the large institutions had managed to break the brokers' solid front on fees. (They then went to 'negotiated' fees, but only for large institutions.[citation needed])

However, corporate governance (at least in the West) has been very much adversely affected by the rise of (largely 'absentee') institutional 'owners'.[citation needed]

[edit]History

Established in 1875, theBombay Stock Exchange is Asia's first stock exchange

In 12th century France the courratiers de change were concerned with managing and regulating the debts of agricultural communities on behalf of the banks. Because these men also traded with debts, they could be called the first brokers. A common misbelief is that in late 13th century Bruges commodity traders gathered inside the house of a man called Van der Beurze, and in 1309 they became the "Brugse Beurse", institutionalizing what had been, until then, an informal meeting, but actually, the family Van der Beurze had a building in Antwerp where those gatherings occurred;[6] the Van der Beurze had Antwerp, as most of the merchants of that period, as their primary place for trading. The idea quickly spread around Flanders and neighboring counties and "Beurzen" soon opened in Ghent and Amsterdam. In the middle of the 13th century, Venetian bankers began to trade in government securities. In 1351 the Venetian government outlawed spreading rumors intended to lower the price of government funds. Bankers in Pisa, Verona, Genoa and Florence also began trading in government securities during the 14th century. This was only possible because these were independent city states not ruled by a duke but a council of influential citizens. Italian companies were also the first to issue shares. Companies in England and the Low Countries followed in the 16th century. The Dutch East India Company (founded in 1602) was the first joint-stock company to get a fixed capital stock and as a result, continuous trade in company stock emerged on the Amsterdam Exchange. Soon thereafter, a lively trade in various derivatives, among which options and repos, emerged on the Amsterdam market. Dutch traders also pioneered short selling - a practice which was banned by the Dutch authorities as early as 1610.[7] There are now stock markets in virtually every developed and most developing economies, with the world's largest markets being in the United States, United Kingdom, Japan, India, China, Canada, Germany (Frankfurt Stock Exchange), France, South Korea and the Netherlands.[8]

[edit]Importance [edit]Function

of stock market

and purpose

The main trading room of theTokyo Stock Exchange,where trading is currently completed through computers.

The stock market is one of the most important sources for companies to raise money. This allows businesses to be publicly traded, or raise additional financial capital for expansion by selling shares of ownership of the company in a public market. The liquidity that an exchange provides affords investors the ability to quickly and easily sell securities. This is an attractive feature of investing in stocks, compared to other less liquid investments such as real estate.[citation needed] History has shown that the price of shares and other assets is an important part of the dynamics of economic activity, and can influence or be an indicator of social mood. An economy where the stock market is on the rise is considered to be an up-and-coming economy. In fact, the stock market is often considered the primary indicator of a country's economic strength and development.[citation needed] Rising share prices, for instance, tend to be associated with increased business investment and vice versa. Share prices also affect the wealth of households and their consumption. Therefore, central banks tend to keep an eye on the control and behavior of the stock market and, in general, on the smooth operation of financial system functions. Financial stability is the raison d'tre of central banks.[citation needed] Exchanges also act as the clearinghouse for each transaction, meaning that they collect and deliver the shares, and guarantee payment to the seller of a security. This eliminates the risk to an individual buyer or seller that the counterparty could default on the transaction.[citation needed] The smooth functioning of all these activities facilitates economic growth in that lower costs and enterprise risks promote the production of goods and services as well as possibly employment. In this way the financial system is assumed to contribute to increased prosperity.[citation needed]

[edit]Relation

of the stock market to the modern financial system

The financial system in most western countries has undergone a remarkable transformation. One feature of this development is disintermediation. A portion of the funds involved in saving and financing, flows directly

to the financial markets instead of being routed via the traditional bank lending and deposit operations. The general public's heightened interest in investing in the stock market, either directly or through mutual funds, has been an important component of this process. Statistics show that in recent decades shares have made up an increasingly large proportion of households' financial assets in many countries. In the 1970s, in Sweden, deposit accounts and other very liquid assets with little risk made up almost 60 percent of households' financial wealth, compared to less than 20 percent in the 2000s. The major part of this adjustment in financial portfolios has gone directly to shares but a good deal now takes the form of various kinds of institutional investment for groups of individuals, e.g., pension funds, mutual funds, hedge funds, insurance investment of premiums, etc. The trend towards forms of saving with a higher risk has been accentuated by new rules for most funds and insurance, permitting a higher proportion of shares to bonds. Similar tendencies are to be found in other industrialized countries. In all developed economic systems, such as the European Union, the United States, Japan and other developed nations, the trend has been the same: saving has moved away from traditional (government insured) bank deposits to more risky securities of one sort or another

[edit]United

States stock market returns

Years to Dec. 31, 2010 Average Annual Return % Average Compounded Annual Return %

15.1

15.1

1.3

10.8

5.1

6.7

10

3.8

5.1

15

9.1

4.7

20

10.9

5.7

30

11.3

7.0

40

10.5

7.7

50

10.0

7.8

60

10.8

8.0

[9]

[edit]The

behavior of the stock market

NASDAQ in Times Square, New York City

From experience we know that investors may 'temporarily' move financial prices away from their long term aggregate price 'trends'. (Positive or up trends are referred to as bull markets; negative or down trends are referred to as bear markets.) Over-reactions may occurso that excessive optimism (euphoria) may drive prices unduly high or excessive pessimism may drive prices unduly low. Economists continue to debate whether financial markets are 'generally' efficient. According to one interpretation of the efficient-market hypothesis (EMH), only changes in fundamental factors, such as the outlook for margins, profits or dividends, ought to affect share prices beyond the short term, where random 'noise' in the system may prevail. (But this largely theoretic academic viewpoint known as 'hard' EMHalso predicts that little or no trading should take place, contrary to fact, since prices are already at or near equilibrium, having priced in all public knowledge.) The 'hard' efficient-market hypothesis is sorely tested by such events as the stock market crash in 1987, when the Dow Jones index plummeted 22.6 percentthe largest-ever one-day fall in the United States.[10] This event demonstrated that share prices can fall dramatically even though, to this day, it is impossible to fix a generally agreed upon definite cause: a thorough search failed to detect any 'reasonable' development that might have accounted for the crash. (But note that such events are predicted to occur strictly by chance, although very rarely.) It seems also to be the case more generally that many price movements (beyond that which are predicted to occur 'randomly') are notoccasioned by new information; a study of the

fifty largest one-day share price movements in the United States in the post-war period seems to confirm this.[10] However, a 'soft' EMH has emerged which does not require that prices remain at or near equilibrium, but only that market participants not be able to systematicallyprofit from any momentary market 'inefficiencies'. Moreover, while EMH predicts that all price movement (in the absence of change in fundamental information) is random (i.e., non-trending), many studies have shown a marked tendency for the stock market to trend over time periods of weeks or longer. Various explanations for such large and apparently non-random price movements have been promulgated. For instance, some research has shown that changes in estimated risk, and the use of certain strategies, such as stop-loss limits and Value at Risk limits, theoretically could cause financial markets to overreact. But the best explanation seems to be that the distribution of stock market prices is non-Gaussian (in which case EMH, in any of its current forms, would not be strictly applicable).[11][12] Other research has shown that psychological factors may result in exaggerated (statistically anomalous) stock price movements (contrary to EMH which assumes such behaviors 'cancel out'). Psychological research has demonstrated that people are predisposed to 'seeing' patterns, and often will perceive a pattern in what is, in fact, just noise. (Something like seeing familiar shapes inclouds or ink blots.) In the present context this means that a succession of good news items about a company may lead investors to overreact positively (unjustifiably driving the price up). A period of good returns also boosts the investor's self-confidence, reducing his (psychological) risk threshold.[13] Another phenomenonalso from psychologythat works against an objective assessment is group thinking. As social animals, it is not easy to stick to an opinion that differs markedly from that of a majority of the group. An example with which one may be familiar is the reluctance to enter a restaurant that is empty; people generally prefer to have their opinion validated by those of others in the group. In one paper the authors draw an analogy with gambling.[14] In normal times the market behaves like a game of roulette; the probabilities are known and largely independent of the investment decisions of the different players. In times of market stress, however, the game becomes more like poker (herding behavior takes over). The players now must give heavy weight to the psychology of other investors and how they are likely to react psychologically. The stock market, as with any other business, is quite unforgiving of amateurs. Inexperienced investors rarely get the assistance and support they need. In the period running up to the 1987 crash, less than 1 percent of the analyst's recommendations had been to sell (and even during the 20002002 bear market, the average did not rise above 5 %). In the run up to 2000, the media amplified the general euphoria, with reports of rapidly rising share prices and the notion that large sums of money could be quickly earned in the so-called new economy stock market. (And later amplified the gloom which descended during the 2000 2002 bear market, so that by summer of 2002, predictions of a DOW average below 5000 were quite common.)

[edit]Irrational

behavior

Sometimes the market seems to react irrationally to economic or financial news, even if that news is likely to have no real effect on the fundamental value of securities itself. But this may be more apparent than real, since often such news has been anticipated, and a counterreaction may occur if the news is better (or worse) than expected. Therefore, the stock market may be swayed in either direction by press releases, rumors, euphoria and mass panic; but generally only briefly, as more experienced investors (especially the hedge funds) quickly rally to take advantage of even the slightest, momentary hysteria. Over the short-term, stocks and other securities can be battered or buoyed by any number of fast marketchanging events, making the stock market behavior difficult to predict. Emotions can drive prices up and down, people are generally not as rational as they think, and the reasons for buying and selling are generally obscure. Behaviorists argue that investors often behave 'irrationally' when making investment decisions thereby incorrectly pricing securities, which causes market inefficiencies, which, in turn, are opportunities to make money.[15] However, the whole notion of EMH is that these non-rational reactions to information cancel out, leaving the prices of stocks rationally determined. The Dow Jones Industrial Average biggest gain in one day was 936.42 points or 11 percent, this occurred on October 13, 2008.[16]

[edit]Crashes
Main article: Stock market crash Further information: List of stock market crashes

The examples and perspective in this section may not represent a worldwide view of the subject. Please improve this article and discuss the issue on the talk page. (March 2009)

Robert Shiller's plot of the S&P Composite Real Price Index, Earnings, Dividends, and Interest Rates, from Irrational Exuberance, 2d ed.[17] In the preface to this edition, Shiller warns, "The stock market has not come down to historical levels: the price-earnings ratio as I define it in this book is still, at this writing [2005], in the mid-20s, far higher than the historical average... People still place too much confidence in the markets and have too strong a belief that paying

attention to the gyrations in their investments will someday make them rich, and so they do not make conservative preparations for possible bad outcomes."

Price-Earnings ratios as a predictor of twenty-year returns based upon the plot by Robert Shiller (Figure 10.1,[17] source). The horizontal axis shows the real price-earnings ratio of the S&P Composite Stock Price Indexas computed in Irrational Exuberance (inflation adjusted price divided by the prior ten-year mean of inflation-adjusted earnings). The vertical axis shows the geometric average real annual return on investing in the S&P Composite Stock Price Index, reinvesting dividends, and selling twenty years later. Data from different twenty year periods is color-coded as shown in the key. See also ten-year returns. Shiller states that this plot "confirms that long-term investorsinvestors who commit their money to an investment for ten full yearsdid do well when prices were low relative to earnings at the beginning of the ten years. Long-term investors would be well advised, individually, to lower their exposure to the stock market when it is high, as it has been recently, and get into the market when it is low." [17]

A stock market crash is often defined as a sharp dip in share prices of equities listed on the stock exchanges. In parallel with various economic factors, a reason for stock market crashes is also due to panic and investing public's loss of confidence. Often, stock market crashes end speculative economic bubbles. There have been famous stock market crashes that have ended in the loss of billions of dollars and wealth destruction on a massive scale. An increasing number of people are involved in the stock market, especially since the social security andretirement plans are being increasingly privatized and linked to stocks and bonds and other elements of the market. There have been a number of famous stock market crashes like the Wall Street Crash of 1929, the stock market crash of 19734, the Black Monday of 1987, the Dot-com bubble of 2000, and the Stock Market Crash of 2008. One of the most famous stock market crashes started October 24, 1929 on Black Thursday. The Dow Jones Industrial lost 50 % during this stock market crash. It was the beginning of the Great Depression.

Another famous crash took place on October 19, 1987 Black Monday. The crash began in Hong Kong and quickly spread around the world. By the end of October, stock markets in Hong Kong had fallen 45.5 %%, Australia 41.8 %%, Spain 31 %%, the United Kingdom 26.4 %%, the United States 22.68 %%, and Canada 22.5 %%. Black Monday itself was the largest one-day percentage decline in stock market history the Dow Jones fell by 22.6 %% in a day. The names Black Monday and Black Tuesday are also used for October 2829, 1929, which followed Terrible Thursdaythe starting day of the stock market crash in 1929. The crash in 1987 raised some puzzles-main news and events did not predict the catastrophe and visible reasons for the collapse were not identified. This event raised questions about many important assumptions of modern economics, namely, thetheory of rational human conduct, the theory of market equilibrium and the hypothesis of market efficiency. For some time after the crash, trading in stock exchanges worldwide was halted, since the exchange computers did not perform well owing to enormous quantity of trades being received at one time. This halt in trading allowed the Federal Reserve system and central banks of other countries to take measures to control the spreading of worldwide financial crisis. In the United States the SEC introduced several new measures of control into the stock market in an attempt to prevent a re-occurrence of the events of Black Monday. Computer systems were upgraded in the stock exchanges to handle larger trading volumes in a more accurate and controlled manner. The SEC modified the margin requirements in an attempt to lower the volatility of common stocks, stock options and the futures market. The New York Stock Exchange and the Chicago Mercantile Exchange introduced the concept of a circuit breaker. The circuit breaker halts trading if the Dow declines a prescribed number of points for a prescribed amount of time.

% drop time of drop

New York Stock Exchange (NYSE) circuit breakers[18]

close trading for

10

before 2 pm

one hour halt

10

2 pm 2:30 pm

half-hour halt

10

after 2:30 pm

market stays open

20

before 1 pm

halt for two hours

20

1 pm 2 pm

halt for one hour

20

after 2 pm

close for the day

30

any time during day close for the day

[edit]Stock

market index

Main article: Stock market index The movements of the prices in a market or section of a market are captured in price indices called stock market indices, of which there are many, e.g., the S&P, the FTSE and the Euronext indices. Such indices are usually market capitalization weighted, with the weights reflecting the contribution of the stock to the index. The constituents of the index are reviewed frequently to include/exclude stocks in order to reflect the changing business environment.

[edit]Derivative

instruments

Main article: Derivative (finance) Financial innovation has brought many new financial instruments whose pay-offs or values depend on the prices of stocks. Some examples are exchange-traded funds (ETFs), stock index and stock options, equity swaps, single-stock futures, and stock index futures. These last two may be traded on futures exchanges (which are distinct from stock exchangestheir history traces back tocommodities futures exchanges), or traded over-the-counter. As all of these products are only derived from stocks, they are sometimes considered to be traded in a (hypothetical) derivatives market, rather than the (hypothetical) stock market.

[edit]Leveraged

strategies

Stock that a trader does not actually own may be traded using short selling; margin buying may be used to purchase stock with borrowed funds; or, derivatives may be used to control large blocks of stocks for a much smaller amount of money than would be required by outright purchase or sales.

[edit]Short

selling

Main article: Short selling In short selling, the trader borrows stock (usually from his brokerage which holds its clients' shares or its own shares on account to lend to short sellers) then sells it on the market, hoping for the price to fall. The trader eventually buys back the stock, making money if the price fell in the meantime and losing money if it rose. Exiting a short position by buying back the stock is called "covering a short position." This strategy may also be used by unscrupulous traders in illiquid or thinly traded markets to artificially lower the price of a stock. Hence most markets either prevent short selling or place restrictions on when and how a short sale can occur. The practice of naked shorting is illegal in most (but not all) stock markets.

[edit]Margin

buying

Main article: margin buying In margin buying, the trader borrows money (at interest) to buy a stock and hopes for it to rise. Most industrialized countries have regulations that require that if the borrowing is based on collateral from other stocks the trader owns outright, it can be a maximum of a certain percentage of those other stocks' value. In the United States, the margin requirements have been 50 %% for many years (that is, if you want to make a $1000 investment, you need to put up $500, and there is often a maintenance margin below the $500). A margin call is made if the total value of the investor's account cannot support the loss of the trade. (Upon a decline in the value of the margined securities additional funds may be required to maintain the account's equity, and with or without notice the margined security or any others within the account may be sold by the brokerage to protect its loan position. The investor is responsible for any shortfall following such forced sales.) Regulation of margin requirements (by the Federal Reserve) was implemented after the Crash of 1929. Before that, speculators typically only needed to put up as little as 10 percent (or even less) of the total investment represented by the stocks purchased. Other rules may include the prohibition of freeriding: putting in an order to buy stocks without paying initially (there is normally a three-day grace period for delivery of the stock), but then selling them (before the three-days are up) and using part of the proceeds to make the original payment (assuming that the value of the stocks has not declined in the interim).

[edit]New

issuance

Main article: Thomson Reuters league tables Global issuance of equity and equity-related instruments totaled $505 billion in 2004, a 29.8 %% increase over the $389 billion raised in 2003. Initial public offerings (IPOs) by US issuers increased 221 %% with 233 offerings that raised $45 billion, and IPOs in Europe, Middle East and Africa (EMEA) increased by 333 %%, from $ 9 billion to $39 billion.

[edit]Investment

strategies

Main article: Stock valuation One of the many things people always want to know about the stock market is, "How do I make money investing?" There are many different approaches; two basic methods are classified by eitherfundamental analysis or technical analysis. Fundamental analysis refers to analyzing companies by their financial statements found in SEC Filings, business trends, general economic conditions, etc.Technical analysis studies price actions in markets through the use of charts and quantitative techniques to attempt to forecast price trends regardless of the company's financial prospects. One example of a technical strategy

is the Trend following method, used by John W. Henry and Ed Seykota, which uses price patterns, utilizes strict money management and is also rooted in risk controland diversification. Additionally, many choose to invest via the index method. In this method, one holds a weighted or unweighted portfolio consisting of the entire stock market or some segment of the stock market (such as the S&P 500 or Wilshire 5000). The principal aim of this strategy is to maximize diversification, minimize taxes from too frequent trading, and ride the general trend of the stock market (which, in the U.S., has averaged nearly 10 %%/year, compounded annually, since World War II).

[edit]Taxation
Main article: Capital gains tax According to much national or state legislation, a large array of fiscal obligations are taxed for capital gains. Taxes are charged by the state over the transactions, dividends and capital gains on the stock market, in particular in the stock exchanges. However, these fiscal obligations may vary from jurisdictions to jurisdictions because, among other reasons, it could be assumed that taxation is already incorporated into the stock price through the different taxes companies pay to the state, or that tax free stock market operations are useful to boost economic growth.

[edit]See

also

Balance sheet Dead cat bounce List of recessions List of market opening times List of stock exchanges List of stock market indices Modeling and analysis of financial markets NASDAQ-100 Securities regulation in the United States Slippage (finance) Stock market bubble Stock market cycles Stock market data systems

[edit]References

1.

^ "World Equity Market Declines: -$25.9 Trillion". Seeking Alpha. Retrieved 2011-05-31.

2.

^ "Quarterly Review Statistical Annex December 2008". Bis.org. September 7, 2008. Retrieved March 5, 2010.

3. 4.

^ "Central Intelligence Agency". Cia.gov. Retrieved 2011-05-31. ^ "What's the difference between a Nasdaq market maker and a NYSE specialist?". Investopedia.com. Retrieved March 5, 2010.

5.

^ Ortega, Edgar (2006-12-04). "UBS, Goldman Threaten NYSE, Nasdaq With Rival Stock Markets". Bloomberg.com. Retrieved 2011-05-31.

6.

^ "16de eeuwse traditionele bak- en zandsteenarchitectuurOude Beurs Antwerpen 1 (centrum) / Antwerp foto". Belgiumview.com. Retrieved March 5, 2010.

7.

^ "PhD thesis 'The world's first stock exchange'". Sites.google.com. Retrieved 2011-05-31.

8.

^ "World Federation of Exchanges Monthly YTD Data". Worldexchanges.org. Retrieved 2011-05-31.

9.

^ "No. HS-38. Stock Prices and Yields: 1900 to 2002"(PDF). Retrieved 2011-05-31.

10. ^

a b

Cutler, D. Poterba, J. & Summers, L. (1991). "Speculative

dynamics". Review of Economic Studies 58: 520546. 11. ^ Mandelbrot, Benoit & Hudson, Richard L. (2006). The Misbehavior of Markets: A Fractal View of Financial Turbulence, annot. ed.. Basic Books. ISBN 0465043577. 12. ^ Taleb, Nassim Nicholas (2008). Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets, 2nd ed.. Random House. ISBN 1400067936. 13. ^ Tversky, A. & Kahneman, D. (1974). "Judgement under uncertainty: heuristics and biases". Science 185 (4157): 1124 1131. doi:10.1126/science.185.4157.1124.PMID 17835457. 14. ^ Stephen Morris and Hyun Song Shin, Oxford Review of Economic Policy, vol. 15, no 3, 1999. 15. ^ Sergey Perminov, Trendocracy and Stock Market Manipulations (2008, ISBN 978-1-4357-5244-3). 16. ^ "News Headlines". Cnbc.com. October 13, 2008. Retrieved March 5, 2010. 17. ^
a b c

Shiller, Robert (2005). Irrational Exuberance (2d ed.).Princeton

University Press. ISBN 0-691-12335-7. 18. ^ Chris Farrell. "Where are the circuit breakers". Retrieved October 16, 2008.

[edit]Further

reading

Hamilton, W. P. (1922). The Stock Market Baraometer. New York: John Wiley & Sons Inc (1998 reprint). ISBN 0-471-24764-2.

[edit]External

Preda, Alex (2009). Framing Finance: The Boundaries of Markets and Modern Capitalism. University of Chicago Press. ISBN 9780226679327.

links

Look up stock market inWiktionary, the free dictionary.

Wikiquote has a collection of quotations related to: Stock market

Stock exchanges at the Open Directory Project Stocks investing at the Open Directory Project

[hide]v d eStock market Types of stocks Participants Exchanges Stock valuation Financial ratios Trading theories and strategies Related terms Broker-dealer Floor broker Floor trader Investor Market maker Proprietary trader Quantitative analyst Stock trader Electronic communication network Market opening times Over-the-counter Stock exchange ( list) Multilateral trading

Common stock Concentrated stock Golden share Growth stock Issued shares Preferred stock Restricted stock Shares a

Alpha Arbitrage pricing theory Beta Book value CAPM Dividend yield Earnings per share Earnings yield Gordon m

Cap rate D/E ratio Dividend cover Dividend payout ratio EV/EBITDA EV/GCI EV/Sales CROCI P/B ratio P/CF ra ratio Treynor ratio

Algorithmic trading Buy and hold Contrarian investing Day trading Efficient-market hypothesis Fundamental analysis M trade Post-modern portfolio theory Random walk hypothesis Style investing Swing trading Technical analysis Trend fo

Block trade Cross listing Dark liquidity Dividend Dual-listed company DuPont Model Flight-to-quality Haircut IPO trend Mean reversion Momentum Open outcry Public float Rally Reverse stock split Share capital Short selling Sli interest Stock market index

View page ratings

Rate this page

What's this? Trustworthy Objective Complete Well-written I am highly knowledgeable about this topic (optional) Submit ratings Categories: Stock market

Log in / create account

Article Discussion Read Edit View history

Main page Contents Featured content Current events Random article Donate to Wikipedia

Interaction Help About Wikipedia Community portal Recent changes Contact Wikipedia

Toolbox Print/export Languages

Dansk Deutsch Espaol Bahasa Indonesia Latvieu Magyar Bahasa Melayu Nederlands Portugus / Srpski Suomi Svenska Ting Vit

This page was last modified on 29 August 2011 at 18:50.

Text is available under the Creative Commons Attribution-ShareAlike License; additional terms may apply. See Terms of use for details. Wikipedia is a registered trademark of the Wikimedia Foundation, Inc., a non-profit organization.

Contact us Privacy policy About Wikipedia Disclaimers Mobile view

Stock market index

From Wikipedia, the free encyclopedia

A comparison of three major U.S. stock indices: theNASDAQ Composite, Dow Jones Industrial Average, andS&P 500. All three have the same height at March 2007. Notice the large dot-com spike on the NASDAQ, a result of the large number of tech. companies on that index.

A stock market index is a method of measuring a section of the stock market. Many indices are cited by news or financial services firms and are used as benchmarks, to measure the performance of portfolios such as mutual funds. Alternatively, an index may also be considered as an instrument (after all it can be traded) which derives its value from other instruments or indices. The index may be weighted to reflect the market capitalization of its components, or may be a simple index which merely represents the net change in the prices of the underlying instruments. Most publicly quoted stock market indices (like the two quoted below) are weighted.
Contents
[hide]

1 Types of indices 2 Index versions 3 Weighting 4 Criticism of capitalization-weighting 5 Indices and passive investment management 6 Ethical stock market indices 7 Environmental stock market indices 8 Innovations Awards to Stock Indices 9 Lists 10 See also

11 Notes 12 References 13 External links

[edit]Types

of indices

Stock market indices may be classed in many ways. A 'world' or 'global' stock market index includes (typically large) companies without regard for where they are domiciled or traded. Two examples are MSCI World and S&P Global 100. A 'national' index represents the performance of the stock market of a given nationand by proxy, reflects investor sentiment on the state of its economy. The most regularly quoted market indices are national indices composed of the stocks of large companies listed on a nation's largest stock exchanges, such as the American S&P 500, the Japanese Nikkei 225, the Russian RTSI, the IndianSENSEX and the British FTSE 100. The concept may be extended well beyond an exchange. The Wilshire 5000 Index, the original total market index, represents the stocks of nearly every publicly traded company in the United States, including all U.S. stocks traded on the New York Stock Exchange (but not ADRs or limited partnerships), NASDAQ and American Stock Exchange. Russell Investment Group added to the family of indices by launching the Russel Global Index.[1] More specialised indices exist tracking the performance of specific sectors of the market. Some examples include the Wilshire US REIT which tracks more than 80 American real estate investment trusts and the Morgan Stanley Biotech Index which consists of 36 American firms in the biotechnology industry. Other indices may track companies of a certain size, a certain type of management, or even more specialized criteria one index published by Linux Weekly News tracks stocks of companies that sell products and services based on the Linux operating environment.

[edit]Index

versions

Some indices, such as the S&P 500, have multiple versions.[2] These versions can differ based on how the index components are weighted and on how dividends are accounted for. For example, there are three versions of the S&P 500 index: price return, which only considers the price of the components, total return, which accounts for dividend reinvestment, and net total return, which accounts for dividend reinvestment after the deduction of a withholding tax.[3] As another example, the Wilshire 4500 and Wilshire 5000 indices have five versions each: full capitalization total return, full capitalization price, float-adjusted total return, float-adjusted price, and equal weight. The difference between the full capitalization, float-adjusted, and equal weight versions is in how index components are weighted.[4][5]

[edit]Weighting

An index may also be classified according to the method used to determine its price. In a priceweighted index such as the Dow Jones Industrial Average, Amex Major Market Index, and the NYSE ARCA Tech 100 Index, the price of each component stock is the only consideration when determining the value of the index. Thus, price movement of even a single security will heavily influence the value of the index even though the dollar shift is less significant in a relatively highly valued issue, and moreover ignoring the relative size of the company as a whole. In contrast, a market-value weighted or capitalizationweighted index such as the Hang Seng Index factors in the size of the company. Thus, a relatively small shift in the price of a large company will heavily influence the value of the index. In a market-share weighted index, price is weighted relative to the number of shares, rather than their total value. Traditionally, capitalization- or share-weighted indices all had a full weighting, i.e. all outstanding shares were included. Recently, many of them have changed to a float-adjusted weighting which helpsindexing. A modified capitalization-weighted index is a hybrid between capitalization weighting and equal weighting. It is similar to a capitalization weighting with one main difference: the largest stocks are capped to a percent of the weight of the total stock index and the excess weight will be redistributed equally amongst the stocks under that cap. Moreover, in 2005, Standard & Poor's introduced the S&P Pure Growth Style Index and S&P Pure Value Style Index which was attribute-weighted. That is, a stock's weight in the index is decided by the score it gets relative to the value attributes that define the criteria of a specific index, the same measure used to select the stocks in the first place. For these two stocks, a score is calculated for every stock, be it their growth score or the value score (a stock cannot be both) and accordingly they are weighted for the index.[6]

[edit]Criticism

of capitalization-weighting

The use of capitalization-weighted indices is often justified by the central conclusion of modern portfolio theory that the optimal investment strategy for any investor is to hold the market portfolio, the capitalizationweighted portfolio of all assets. However, empirical tests conclude that market indices are not efficient. [citation
needed]

This can be explained by the fact that these indices do not include all assets or by the fact that the

theory does not hold. The practical conclusion is that using capitalization-weighted portfolios is not necessarily the optimal method. As a consequence, capitalization-weighting has been subject to severe criticism (see e.g. Haugen and Baker 1991, Amenc, Goltz, and Le Sourd 2006, or Hsu 2006), pointing out that the mechanics of capitalization-weighting lead to trend-following strategies that provide an inefficient risk-return trade-off. Also, while capitalization-weighting is the standard in equity index construction, different weighting schemes exist. First, while most indices use capitalization-weighting, additional criteria are often taken into account, such as sales/revenue and net income (see the Guide to the Dow Jones Global Titan 50 Index, January 2006). Second, as an answer to the critiques of capitalization-weighting, equity indices with different weighting schemes have emerged, such as "wealth"-weighted (Morris, 1996), fundamental-

weighted (Arnott, Hsu and Moore 2005), diversity-weighted (Fernholz, Garvy, and Hannon 1998) or equal-weighted indices.

[edit]Indices

and passive investment management

There has been an accelerating trend in recent decades to create passively managed mutual funds that are based on market indices, known as index funds. Advocates claim that index funds routinely beat a large majority of actively managed mutual funds; one study[citation needed] claimed that over time, the average actively managed fund has returned 1.8% less than the S&P 500 index - a result nearly equal to the average expense ratio of mutual funds (fund expenses are a drag on the funds' return by exactly that ratio). Since index funds attempt to replicate the holdings of an index, they obviate the need for and thus many costs of the research entailed in active management, and have a lower churn rate (the turnover of securities which lose fund managers' favor and are sold, with the attendant cost of commissions and capital gains taxes). Indices are also a common basis for a related type of investment, the exchange-traded fund or ETF. Unlike an index fund, which is priced daily, an ETF is priced continuously, is optionable, and can be sold short.

[edit]Ethical

stock market indices

A notable specialised index type is those for ethical investing indices that include only those companies satisfying ecological or social criteria, e.g. those of The Calvert Group, KLD, FTSE4Good Index,Dow Jones Sustainability Index and Wilderhill Clean Energy Index. In 2010, the OIC announced the initiation of a stock index that complies with Islamic law's ban on alcohol, tobacco and gambling. Other such equities, such as the Dow Jones Islamic Market World Index, already exist.[7] Another important trend is strict mechanical criteria for inclusion and exclusion to prevent market manipulation, e.g. in Canada when Nortel was permitted to rise to over 30% of the TSE 300 index value. Ethical indices have a particular interest in mechanical criteria, seeking to avoid accusations of ideological bias in selection, and have pioneered techniques for inclusion and exclusion of stocks based on complex criteria. Another means of mechanical selection is mark-to-future methods that exploit scenarios produced by multiple analysts weighted according to probability, to determine which stocks have become too risky to hold in the index of concern. Critics of such initiatives argue that many firms satisfy mechanical "ethical criteria", e.g. regarding board composition or hiring practices, but fail to perform ethically with respect to shareholders, e.g.Enron. Indeed, the seeming "seal of approval" of an ethical index may put investors more at ease, enabling scams. One response to these criticisms is that trust in the corporate management, index criteria, fund or index manager, and securities regulator, can never be replaced by mechanical means, so "market transparency" and "disclosure" are the only long-term-effective paths to fair markets.

[edit]Environmental

stock market indices

An environmental stock market index aims to provide a quantitative measure of the environmental damage caused by the companies in an index. Indices of this nature face much of the same criticism as Ethical indices do that the 'score' given is partially subjective. However, whereas 'ethical' issues (for example, does a company use a sweatshop) are largely subjective and difficult to score, an environmental impact is often quantifiable through scientific methods. So it is broadly possible to assign a 'score' to (say) the damage caused by a tonne of mercury dumped into a local river. It is harder to develop a scoring method that can compare different types of pollutant for example does one hundred tonnes of carbon dioxide emitted to the air cause more or less damage (via climate change) than one tonne of mercury dumped in a river (and poisoning all the fish). Generally, most environmental economists attempting to create an environmental index would attempt to quantify damage in monetary terms. So one tonne of carbon dioxide might cause $100 worth of damage, whereas one tonne of mercury might cause $50,000 (as it is highly toxic). Companies can therefore be given an 'environmental impact' score, based on the cost they impose on the environment. Quantification of damage in this nature is extremely difficult, as pollutants tend to be market externalities and so have no easily measurable cost by definition.

[edit]Innovations

Awards to Stock Indices

Your stock index chart makes me feel much better...

The William F. Sharpe Indexing Achievement Awards are presented annually in order to recognize the most important contributions to the indexing industry over the preceding year.

Most Innovative Benchmark Index

2004 CBOE S&P 500 BuyWrite Index (BXM)[8] 2005 FTSE/RAFI Fundamental Index Series 2006 Standard and Poors Case-Shiller House Prices Indices 2007 - CBOE S&P 500 PutWrite Index (PUT)[9]

Most Innovative ETF

2004 iShares MSCI EAFE (EFA) and Emerging Markets 2005 EasyETF GSCI Commodities ETF 2006 PowerShares DB Commodity Index Tracking Fund (DBC) and PowerShares G10 Currency Harvest Fund (DBV)

2007 - SPDR DJ Wilshire International Real Estate ETF

Most Innovative Index Product

2004 CBOE Volatility Index (VIX) Futures 2005 Options on Vanguard VIPERS at the CBOE 2006 Chicago Board Options Exchange Options on the CBOE Volatility Index (VIX) 2007 - iPath ETNs 2009 - Thomson Reuters Realized Volatility Index

Best Index-related Research Paper

2004 Steven Schoenfeld 2005 Rob Arnott 2006 Eugene F. Fama and Kenneth R. French 2007 - Benchmarking Benchmarks: Measuring Characteristic Selectivity, By Kingsley Fong, David R. Gallagher, Adrian Lee, University of New South Wales

Lifetime Achievement Award

2004 Tim Harbert 2005 William Sharpe and Nathan Most 2006 Burton G. Malkiel and Ronald J. Ryan 2007 - John C. Bogle, Paul A. Samuelson, Patricia C. Dunn, William L. Fouse and John A. Prestbo

[edit]Lists

Index of accounting articles Index of economics articles Index of management articles List of stock exchanges List of stock market indices Outline of finance Outline of marketing

[edit]See

also

Exchange-traded fund Index (economics)

Index fund Passive management

[edit]Notes

1. ^ Russell.com 2. ^ "S&P - Indices > Equity Indices - S&P 500 - Index Table". 3. ^ "Description". 4. ^ "Wilshire: Index Calculator Result". 5. ^ "Dow Jones Wilshire > DJ Wilshire 5000/4500 Indexes > Methodology". 6. ^ S&P methodology via Wikinvest 7. ^ Haris Anwar,Muslim-Majority Nations Plan Stock Index to Spur Trade: Islamic Finance, Bloomberg L.P., Nov. 25, 2010. 8. ^ CBOE - Micro Site 9. ^ CBOE - Micro Site

[edit]References
Amenc, N., F. Goltz, and V. Le Sourd, 2006, Assessing the Quality of Stock Market Indices, EDHEC Publication

Arnott, R.D., J. Hsu, and P. Moore, 2005, Fundamental Indexation, Financial Analysts Journal 60(2), 8399.

Broby, D.P., 2007 "A Guide to Equity Index Construction", Risk Books. Fernholz, R., R. Garvy, and J. Hannon, 1998, Diversity-Weighted Indexing, Journal of Portfolio Management, 24(2), 7482

Haugen, R.A., and N.L. Baker, 1991, The Efficient Market Inefficiency of Capitalization-Weighted Stock Portfolios, Journal of Portfolio Management

Hsu, Jason, 2006, Cap-Weighted Portfolios are Sub-optimal Portfolios, Journal of Investment Management, 4(3), 110

[edit]External

links

Stock Index Profile at Wikinvest

[hide]v d eStock market Types of stocks Participants Exchanges Stock valuation

Common stock Concentrated stock Golden share Growth stock Issued shares Preferred stock Restricted stock Shares a Broker-dealer Floor broker Floor trader Investor Market maker Proprietary trader Quantitative analyst Stock trader

Electronic communication network Market opening times Over-the-counter Stock exchange (

list) Multilateral trading

Alpha Arbitrage pricing theory Beta Book value CAPM Dividend yield Earnings per share Earnings yield Gordon model

Financial ratios Trading theories and strategies

Cap rate D/E ratio Dividend cover Dividend payout ratio EV/EBITDA EV/GCI EV/Sales CROCI P/B ratio P/CF ratio P/E

Algorithmic trading Buy and hold Contrarian investing Day trading Efficient-market hypothesis Fundamental analysis M modern portfolio theory Random walk hypothesis Style investing Swing trading Technical analysis Trend following

Related terms

Block trade Cross listing Dark liquidity Dividend Dual-listed company DuPont Model Flight-to-quality Haircut IPO Ma trend Mean reversion Momentum Open outcry Public float Rally Reverse stock split Share capital Short selling Slipp interest Stock market index

View page ratings

Rate this page

What's this? Trustworthy Objective Complete Well-written I am highly knowledgeable about this topic (optional) Submit ratings Categories: Stock market | Stock market indices

Log in / create account

Article Discussion Read Edit View history

Main page Contents Featured content Current events Random article Donate to Wikipedia Interaction Help About Wikipedia Community portal Recent changes Contact Wikipedia Toolbox Print/export Languages

Bosanski esky Dansk Deutsch Espaol Euskara Franais Hrvatski Bahasa Indonesia Italiano Lietuvi Bahasa Melayu Nederlands Norsk (bokm l) Polski Portugus Romn Slovenina Suomi Svenska Trke Ting Vit
This page was last modified on 6 August 2011 at 13:52. Text is available under the Creative Commons Attribution-ShareAlike License; additional terms may apply. See Terms of use for details. Wikipedia is a registered trademark of the Wikimedia Foundation, Inc., a non-profit organization.

Contact us Privacy policy About Wikipedia Disclaimers Mobile view

New intro fro NSE

A stock market index is a measure of the relative value of a group of stocks in numerical terms. As the stocks within an index change value, the index value changes. An index is important to measure the performance of investments against a relevant market index

ABOUT INDICES A stock market index is created by selecting a group of stocks that are representative of the whole market or a specified sector or segment of the market. An Index is calculated with reference to a base period and a base index value. An Index is used to give information about the price movements of products in the financial, commodities or any other markets. Financial indexes are constructed to measure price movements of stocks, bonds, T-bills and other forms of investments. Stock market indexes are meant to capture the overall behaviour of equity markets.

Abt index

An Index is used to give information about the price movements of products in the financial, commodities or any other markets. Financial indexes are constructed to measure price movements of stocks, bonds, T-bills and other forms of investments. Stock market indexes are meant to capture the overall behaviour of equity markets. A stock market index is created by selecting a group of stocks that are representative of the whole market or a specified sector or segment of the market. An Index is calculated with reference to a base period and a base index value. Stock market indexes are useful for a variety of reasons. Some of them are : They provide a historical comparison of returns on money invested in the stock market against other forms of investments such as gold or debt. They can be used as a standard against which to compare the performance of an equity fund. In It is a lead indicator of the performance of the overall economy or a sector of the economy

Stock indexes reflect highly up to date information Modern financial applications such as Index Funds, Index Futures, Index Options play an an important role in financial investments and risk management

about iisl
ndia Index Services & Products Limited (IISL), a joint venture between NSE and CRISIL Ltd. (formerly the Credit Rating Information Services of India Limited), was setup in may 1998 to provide a variety of indices and index related services and products for the Indian capital markets.It has a licensing and marketing agreement with Standard and Poor's (S&P), the world's leading provider of investible equity indices, for co-branding equity indices. IISL provides a broad range of services, products and professional index services. It maintains over 80 equity indices comprising broad-based benchmark indices, sectoral indices and customised indices. Many investment and risk management products based on IISL indices have been developed in the recent past, within India and abroad. These include index based derivatives traded on NSE, Singapore Exchange (SGX) and Chicago Mercantile Exchange (CME) and a number of index funds and exchange traded funds. About S&P S&P owns the most important index in the world, the S&P 500 index, which is the foundation of the largest index funds and most liquid index futures markets in the world. The S&P 500 index is used by professionals around the world as the standard measure of the US market. Over US$ 800 billion is indexed, or directly linked, to the S&P 500 through index or tracker funds, more than any other index in the world. Daily trading volumes of derivatives transactions based on the S&P 500 amount to over US$ 50 billion. Standard & Poor's plays an active role in the construction, development and maintenance of IISL's indices and brings its international expertise to the joint venture. With this involvement, IISL is committed to providing to the market the same assured quality, objectivity, integrity and service which are a constant source of inspiration to the international markets. This marks the first time Standard & Poor's, the world's largest index services provider, has offered its brand name and technical support to any such venture anywhere in the world. Objectives of IISL IISL pools the index development efforts of CRISIL and NSE into a coordinated whole - India's first specialised company focused upon the index as a core product . IISL has the following objectives: To develop, construct and maintain indices on Indian equities that serve as useful market performance benchmarks and are the underlying indices for derivatives trading To provide data and information on the trading activity in the Indian stock markets All the erstwhile indices of NSE and CRISIL, such as Nifty, Nifty Junior, Defty, CRISIL 500, CRISIL Midcap 200 index etc. have been transferred to IISL which now maintains, develops, compiles and disseminates the indices.

Index Licensing
IISL Indices are used as an underlying for a wide range of financial instruments offered by financial institutions, asset management companies, etc., to their investors worldwide. These include structured financial products as well as index funds and exchange traded funds. A license from IISL is required for creating a product based on or linked to an IISL index. IISL also offers annual global licenses covering all index-linked financial instruments by an institution, as well as licenses for single transactions. Benchmarking Investors, asset managers and financial institutions may use IISL indices to track the performance of funds, or as benchmarks for their actively managed portfolios, in particular. If an institution is benchmarking the performance of its product to any of the IISL Indices, prior approval is required from IISL along with payment of fees, where applicable. If the AMC or the financial institution uses the IISL trademarks and the indices as an underlying for their Products, then it is mandatory for these financial institutions to seek IISLs prior approval and executing a license agreement with IISL. Licensed Uses and Applications

Structured Products & Derivatives The market for structured products and derivatives ranges from un-leveraged indexed notes to payouts for sophisticated, risk tolerant holders. IISL index-linked derivatives allow investors to create, control or maximize market exposure. Options, warrants, notes, bonds and trusts linked to IISL indices can be issued by prospective clients. Index Funds Indexing continues to gain popularity among individual and institutional investors. Most major mutual fund families have responded to client demands and added funds indexed to the IISL Indices. Index Funds today are a source of investment for investors looking at a long term, less risky form of investment. The success of index funds depends on their low volatility and therefore the choice of the index. Exchange Traded Funds The expansion of the exchange-traded funds market to the Indian exchange is a testament to the growing popularity of this product. The ETFs offers the ability to establish long-term investments based on the market performance of the top companies in India, with the ease of a single transaction and will provide the tools needed to capture the investment opportunities created by economic shift. For the mechanism to work, potential arbitragers need to have full, timely knowledge of a fund's holdings. The success of ETFs on indices depends on their low volatility and tracking error therefore the choice of the index. Annuities and Other Insurance Products Variable life, variable and fixed annuities and universal life products are structured to provide a return based on an IISL index's growth. Like a traditional annuity, purchasers receive a guaranteed return of principal along with a minimum interest rate. However, annuities linked to the IISL indices provide greater return potential by enabling purchasers to benefit from growth in the Indian stock market. Guaranteed Funds and Structured Products While passive index investing continues to grow, guaranteed products have long been a hallmark of these markets. In response to client demand, major asset management companies and banks issue index products such as tracker funds, warrants and individual certificates linked to IISL indices.

What should a stock market index be?

A stock market index should capture the behaviour of the overall equity market. Movements of the index should represent the returns obtained by "typical" portfolios in the country.
What do the ups and downs of an index mean?

They reflect the changing expectations of the stock market about future dividends of India's corporate sector. When the index goes up, it is because the stock market thinks that the prospective dividends in the future will be better than previously thought. When prospects of dividends in the future become pessimistic, the index drops. The ideal index gives us instant-to-instant readings about how the stock market perceives the future of India's corporate sector.
What is the basic idea in an index?

Every stock price moves for two possible reasons: news about the company (e.g. a product launch, or the closure of a factory, etc.) or news about the country (e.g. nuclear bombs, or a budget announcement, etc.). The job of an index is to purely capture the second part, the movements of the stock market as a whole (i.e. news about the country). This is achieved by averaging. Each stock contains a mixture of these two elements - stock news and index news. When we take an average of returns on many stocks, the individual stock news tends to cancel out. On any one day, there would be good stock-specific news for a few companies and bad stock-specific news for others. In a good index, these will cancel out, and the only thing left will be news that is common to all stocks. The news that is common to all stocks is news about India. That is what the index will capture.
What kind of averaging is done?

For technical reasons, it turns out that the correct method of averaging is to take a weighted average, and give each stock a weight proportional to its market capitalisation. Suppose an index contains two stocks A and B. A has a market capitalisation of 1000 crore and B has a market capitalisation of 3000 crore. Then we attach a weight of 1/4 to movements in A and 3/4 to movements in B.
What is the portfolio interpretation of index movements?

It is easy to create a portfolio, which will reliably get the same returns as the index. i.e. if the index goes up by 4%, this portfolio will also go up by 4%. Suppose an index is made of two stocks, one with a market cap of 1000 crore and another with a market cap of 3000 crore. Then the index portfolio will assign a weight of 25% to the first and 75% weight to the second. If we form a portfolio of the two stocks, with a weight of 25% on the first and 75% on the second, then the portfolio returns will equal the index returns. So if you want to buy 1 lakh of this two-stock index, you would buy 25,000 of the first and 75,000 of the second; this portfolio would exactly

mimic the two-stock index. A stock market index is hence just like other price indices in showing what is happening on the overall indices -- the wholesale price index is a comparable example. In addition, the stock market index is attainable as a portfolio.
Why are indices important?

Traditionally, indices have been used as information sources. By looking at an index we know how the market is faring. This information aspect also figures in myriad applications of stock market indices in economic research. This is particularly valuable when an index reflects highly up to date information (a central issue which is discussed in detail ahead) and the portfolio of an investor contains illiquid securities - in this case, the index is a lead indicator of how the overall portfolio will fare. In recent years, indices have come to the fore owing to direct applications in finance, in the form of index funds and index derivatives. Index funds are funds which passively 'invest in the index'. Index derivatives allow people to cheaply alter their risk exposure to an index (this is called hedging) and to implement forecasts about index movements (this is called speculation). Hedging using index derivatives has become a central part of risk management in the modern economy. These applications are now a multi-trillion dollar industry worldwide, and they are critically linked up to market indices. Finally, indices serve as a benchmark for measuring the performance of fund managers. An all-equity fund should obtain returns like the overall stock market index. A 50:50 debt:equity fund should obtain returns close to those obtained by an investment of 50% in the index and 50% in fixed income. A well-specified relationship between an investor and a fund manager should explicitly define the benchmark against which the fund manager will be compared, and in what fashion.
What kinds of indices exist?

The most important type of market index is the broad-market index, consisting of the large, liquid stocks of the country. In most countries, a single major index dominates benchmarking, index funds, index derivatives and research applications. In addition, more specialised indices often find interesting applications. In India, we have seen situations where a dedicated industry fund uses an industry index as a benchmark. In India, where clear categories of ownership groups exist, it becomes interesting to examine the performance of classes of companies sorted by ownership group.