Index
Family XII · Other terms
Not to be confused with stock index, stock market index, stock index futures.
Index is a statistical composite that represents the value of a basket of underlying assets, allowing observers to gauge the performance of a market segment or asset class. It is calculated by weighting the prices or values of its constituents according to a defined methodology, which may be price-weighted, market-capitalization-weighted, or equal-weighted. Indices serve as benchmarks for investment performance and as the basis for index funds and derivatives.
Calculation and Weighting
The value of an index is derived from the prices of its constituent assets, combined using a specific weighting scheme. Common methods include:
- Market-capitalization weighting: Each component is weighted by its total market value, so larger companies have greater influence.
- Price weighting: Components are weighted by their per-share price, giving higher-priced stocks more impact.
- Equal weighting: All components are assigned the same weight, regardless of size or price.
The choice of weighting affects the index's sensitivity to price changes in individual constituents.
Worked Example
Consider a simple price-weighted index of three stocks. The index is calculated by summing the prices and dividing by a divisor. Suppose the divisor is 3.
If Stock A rises to $60, the sum becomes $110, and the index rises to 36.67, assuming the divisor remains 3.
Uses and Variations
Indices are used to track market performance, create index funds, and structure derivatives such as futures and options. They can be broad-based, covering entire markets, or narrow, focusing on specific sectors, regions, or strategies. The methodology and constituent list are typically maintained by a committee or rules-based process, and may be adjusted periodically to reflect market changes.
Often confused with
- stock index
- A stock index is a specific type of index that tracks a group of stocks, whereas an index can track any asset class; the presence of 'stock' in the name indicates the underlying assets are equities.
- stock market index
- A stock market index is an index that represents a segment of the stock market, often broader than a stock index; the term 'market' implies a wider scope, such as all listed companies in a country.
- stock index futures
- Stock index futures are exchange-traded derivative contracts whose price is derived from a specified stock market index, obligating the buyer or seller to settle in cash at a future date based on the index level.