Security market indices

1(a) Examples of:

(1) Price weighted index it is an arithmetic average of the prices of the securities included in the
index. The divisor of a price-weighted index is adjusted for stock splits and changes in the
composition of the index when securities are added or deleted, such that the index value is
unaffected by such changes.

Example

Lets assume the market close on day 1, company ABC closed at $20, and company XYZ closed at $60 .

The value of a price-weighted index of these two stocks is ($20+$60) / 2 = 40 at the close of trading

If company XYZ incurred a 2-for-1 split the day after you computed your average, you would divide
$60 by 2 to get a split price of $30 .

The new denominator will be;

Add this new price to the other stock prices ($30+$20=$50)

Divide this value by the price-weighted average, computed on the day immediately before the stock
split $50/$40 =1.25 the new divisor. (C. Taylor, 2018)

By: C. Taylor
Reviewed by: Ryan Cockerham, CISI Capital Markets and Corporate Finance
Updated November 21, 2018

(ii) Equally weighted index it is calculated as the arithmetic average return of the index stocks.

Example

Let us assume there are four stocks in the equal-weighted index, Stock A, Stock B, Stock C, Stock D.
Prices of each stock are as follows:

STOCKS PRICE IN ($) WEIGHT PRODUCT

(100/4) (price*weig
ht)
A 100.00 25% 25

B 95.00 25% 23.75

C 115.00 25% 28.75

D 50.00 25% 12.50

Equally weighted =25+23.75+28.75.12.50 = 90

(iii) Market capitalization-weighted index is a capital market index in which the constituent
securities are weighted based on their market capitalization, which equals the product of its
price per share and total number of common shares outstanding. The weight of each security is
calculated by the ratio of its market capitalization to the sum of market capitalization of all
constituent securities.

Example

Work out the index value on 1 Jan 2017 and 31 Dec 2017 based on the following data:

Stock Price Market Capitalization

Shares
31 Dec
Stock Outstanding 1 Jan 2017 31 Dec 2017 1 Jan 2017
2017
(Q) (P0) (P1) (Q×P0)
(Q×P1)
A 25,000 $15 $20 $375,000 $500,000
B 50,000 $34 $40 $1,700,000 $2,000,000
C 100,000 $52 $60 $5,200,000 $6,000,000
D 50,000 $120 $100 $6,000,000 $5,000,000
Sum 225,000 $13,275,000 $13,500,000

Assuming the divisor is 1, weight will be worked as follows

$375,000
wA (1 Jan 2017) = = 2.82%
$13,275,000
Similarly, we work out that weights of Stock B, C and D are 12.81%, 39.17% and 45.20% respectively.

The weights for Stock A, B, C and D as on 31 Dec 2017 are 3.77%, 15.07%, 45.20% and 37.66%
respectively.

You can see that weights have increased where the stock price has increased and vice versa.

Index as at 1 Jan 2017

= 2.82%×$15 + 12.81%×$34 + 39.17%×$52 + 45.20%×$120
= 79.38

In the same fashion, we find out that the index value as at 31 Dec 2017 is 71.56. The biggest drag on the
index is the decline in price of Stock D because it has the highest weight

By Obaidullah Jan, ACA, CFA and last modified on May 23, 2019

Studying for CFA® Program? Access notes and question bank for CFA ® Level 1 authored by me
at AlphaBetaPrep.com

(iv) Commodity indices