Financial Markets and Institutions

Group 4: LiabilitiesAbhirup Das 09BM8002

Tushar Chaudhary 09BM8056Devdut Saha 09BM8083

Ungratwar Sujeeth 09BM8097Saurabh Kumar Gupta 06AG3804

Stock Indices

Global: MSCI World, S&P Global 100 National: NSE, S&P 500, Nikkei 225,

FTSE 100

Sectoral: Wilshire US REIT (80 American real estate trusts), Morgan Stanley Biotech Index (36 American biotechnology firms).

Stock Index calculation

Price Weighted Index Capitalization weighted/ Market-value

weighted Market Share weighted Float Capitalization weighted Free Float Capitalization

Price Weighted Index

The price of each component stock is the only consideration when determining the value of the index.

E.g.  Dow Jones Industrial Average, Amex Major Market Index, and NYSE ARCA Tech 100 Index

Example – DJIA, 11-Apr-08

Step 1: Sum of all the stock values80.35+36.11+45.06+45.56+38.20+37.69+78.43+75.71+89.60+23.71+61.33+49.64+89.55+36.75+20.17+46.57+28.38+22.08+118.78+66.33+43.86+55.85+41.71+29.11+

20.92+70.18+71.85+35.83+54.66+31.35 = 1545.32

Step 2: Divide by official industrial averages divisor1545.32 / 0.122834016 = 12580.55

Step 3: Adjust the after hours trading12580.55 -256.56 = 12323.99

Capitalization-weighted index

Factors in the size of the company (volume of shares)

No. of shares* Price of share= Contribution of a company

Divided by the divisor and adjusted for after hours trading

E.g. Hang Seng Index

Market share weighted index

Price is weighted relative to the number of shares, rather than their total value.

(No. of shares of ABC/ Total no. of shares)* Price of Share of ABC

Float capitalization weighted index

Hybrid between Capitalization and equal weighting

Largest stock (over the cap) constitutes certain percentage of the index

Remaining portion is determined by equal weighting of the stocks under the cap

Free float capitalization

Free float shares: Shares free for trading Index calculation: Step 1: Calculate the free float market cap-

cost of buying all the shares Step 2: Add the free float market cap of all

the companies Step 3: Make it relative to the index base.

Index P/E Ratio

P/E of stock

P/E = Stock Price / EPS EPS = Net Earnings / Outstanding Shares 

Note that there are three types of EPS numbers: 

Trailing EPS – last year’s numbers and the only actual EPS

Current EPS – this year’s numbers, which are still projections

Forward EPS – future numbers, which are obviously projections 

Index P/E Ratio….(con.)

P/E of Index

For Example Sensex

Market Capitalization=Share Price *Total shares

outstanding

Earnings=EPS*Free Float Adjustment factor*Total Shares

outstanding

Sensex P/E= ∑ (Market Capitalization)/∑ (Earnings)

Index P/E Ratio….(con.)

Used to predict the index

For Example

PE of Index: 10

EPS of Index: 1000

Then Index= PE*EPS =10000

Index P/E Ratio….(con.)

Used to predict the index

For Example

PE of Index: 12

EPS of Index: 900

Then Index= PE*EPS =10800

Dollex

•Launched by BSE DOLLEX-30 on 25th July 2001 with same base year and base value as Sensex.

•Preceded by DOLLEX-200 in 1994

•One value reflects the changes in both the stock prices and the foreign exchange variation.

•Would help foreign investors measure their 'real returns' after providing for exchange rate fluctuations.

Dollex

Formula:

Utility:

Source: http://www.bseindia.com/whtsnew/dollex.asp

•Further steps: Introduced Dollex-100 on 22 May 2006

BSE IPO Index

•Launched on 24 August 2004 with 45 companies with a criterion of at least 10 scripts any time

•Basic purpose to track primary market conditions with respect to secondary market

•The index will measure growth in investor wealth for a period of two years after the listing of a firm.

BSE IPO Index

•The performance of newly listed stocks is highly dependent on the state of the entire market. BSE IPO index and the BSE 100 index are seen moving in tandem in the chart alongside.

• But it will help investors to get a fair idea on how the primary market has rewarded them in comparison to the secondary market. For instance, the Sensex has given a return of 179.83% since May 3, 2004, compared with 94.75% return given by the BSE IPO index

Source : Indian Express

Definition:•Volatility is defined as "rate and magnitude of changes in prices” and in finance often referred to as risk.

•Volatility Index is a measure of market’s expectation of volatility over the near term by studying the amount by which an underlying Index is expected to fluctuate.

• Chicago Board of Options Exchange (CBOE) was the first to introduce the volatility index for the US markets in 1993 based on S&P 100 Index option prices.

India VIX

India VIX

• India VIX is a volatility index computed by NSE based on the order book of NIFTY Options. India VIX indicates the investor’s perception of the market’s volatility in the near term i.e. it depicts the expected market volatility over the next 30 calendar days. It is launched on July 19, 2010

•It would give a lot of security to investors and traders, who face uncertainty, because the new product will empower them with better information and foresight. They will use the product to hedge their portfolios against the risk arising out of volatility

•NSE will be applying to the Securities and Exchange Board of India (SEBI) for permission to start derivatives on the index, after it has been tracked for a suitable period.

Indian Context

The Relationship Between Stock Markets OfMajor Developed Countries And AsianEmerging Markets

There has been an increasing interdependence between most of the developed and emerging markets since the 1987 Stock Market Crash.

This interdependence intensified after the 1997 Asian Financial Crisis.

Relaxation of capital controls started with the stock market liberalization when the United States took an important step by passing the U.S. Securities Act Amendments of 1975, which deregulated stock brokerage commission rates.

This easing on both the inflow and outflow of capital is significantly observed after 1980.

As for the Asian emerging markets, they have been liberalized at different times as summarized below. Three different indicators of liberalization: the Official Liberalization Date, the First Country Fund and the First ADR are shown.

The benefit of international diversification, however, is limited when equity markets are co integrated, because the presence of common factors limits the amount of independent variation.

With such a likelihood that the benefits of international diversification may be reduced, this study is thus interested in investigating if Asian emerging equity markets do indeed move together with the stock markets of major developed countries.

To do this we use the concept of co- integration, so that the right market can be chosen for portfolio diversification.

One of the reasons why international diversification undertaken rather than just domestic diversification is that there is a tendency for returns on individual securities within an economy to move together.

Secondly there are gains from international diversification because returns in any one country are influenced by natural and man-made catastrophes, business cycles, and government policies whose effects are limited to or felt most strongly in the economy of that affected country.

The risk of an internationally diversified portfolio can be reduced to less than half the level of a diversified United States portfolio, implying that international diversification is beneficial.

Studies have found that the United States market is a ‘global factor’ which leads both the developed and most of the Asian emerging markets.

The data used in this study consists of weekly stock indices of the major stock exchanges. The data are obtained from Datastream and cover the period January 1, 1981 through December 31, 2002.

To examine the trend of interdependence between the developed and emerging markets over time, the stock indices from the sample are further sub-divided into three sub-periods: January 1, 1981 – December 31, 1986 (Period I), January 1, 1987 – December 31 1996 (Period II) and January 1, 1997 – December 31, 2002 (Period III).

The model consists of the dependent variables: Asian indices and independent variables: Developed countries indices.

This analysis is thus played by the relationship yE(t) = a + byD(t) + e(t) where the subscript E denotes the emerging market’s stock index (i.e. the stock indices for Malaysia, Thailand, Korea, Taiwan, Singapore and Hong Kong). The subscript D denotes the developed country’s stock index (i.e. stock indices for the United States, United Kingdom and Japan) and e(t) denotes the error term.

Co integration is thus required in order to reach the conclusion of a stable equilibrium relationship between the stock indices of the developed and emerging markets.

We conclude that all stock indices in our study are I(1) i.e. non-stationary series are integrated of order one and hence co integrating equation (1) can be used to regress the stock indices of the emerging market on those of the developed markets.

Hence the results originally obtained indicate a good measure of co-movement between stock indices between the developed and emerging markets.

For the period 1981-1986 as indicated in Table 1, no co-movements were found for the countries in our study.

1987-1996 encompasses the period when the United States stock market declined from its peak, crashed in October 1987 (Black Monday), and the years immediately following the crash. During this period, co-movement exists between most of the emerging and developed markets.

Similar reasoning of the overall increase in trade flows also applies to the third sub-period 1997-2002, which commences with the 1997 Asian Financial Crisis.

Conclusion

We find that Singapore and Taiwan are co-integrating with Japan while Hong Kong is co-integrating with the United States and the United Kingdom.

The relationship between the developed and emerging markets also change over time, as shown by the differing co movements between them in each of the sub-periods.

As a result of more markets moving together, the aim of international portfolio diversification to minimize risk is more limited after the 1987 Stock Market Crash.

This limitation is further exemplified after the 1997 Asian Financial Crisis.