Today we're going to have brief a look at indices in financial markets.
What are they?
Effectively an index is something that takes daily financial data from companies and then processes it all to give a figure, which will then change in-line with the performance of these companies intra-daily.
What are they used for?
- Benchmarking funds
- Derivative and spread bet traders
E.G.
The Masked AIM Trader's Index has three companies in it:
Date = 14/10/2013
Share Price Shares In Issue Market Cap
1. £0.10 10 £1
2. £0.20 5 £1
3. £0.30 2 £0.60
= £0.60 =£2.60
Now, in order for this information to be useful we have to compare it with some more data, let's assume that none of these companies have issued more shares and jump a year into the future:
Date = 14/10/2014
Share Price Shares In Issue Market Cap
1. £0.50 10 £5
2. £0.40 5 £2
3. £0.10 2 £0.20
= £1.00 =£7.20
So far, so what?
Now, most indices (like the UK ones) work off of market capitalisation; so the indices are size weighted.
Let's pretend that I started my index a year ago at 1000 points (conveniently this is where the FTSE started at in the 1980s):
To calculate the value of this index in points, we would now have to do the following:
- 1000 is the starting value in points
- 7.20 is the new market capitalisation
- 2.60 was the old market capitalisation
1000* 7.20/2.60 = 2769 Points
So, using market capitalisation the index has almost trebled in a year.
Is there another way?
Well, in the US they do things a little differently and for the Dow Jones 30 they base things on share price weightings, so for my index we would look at it like this:
- 1000 is the starting value in points
- 1.0 is the new share price
- 0.6 is the old share price
1000*1.00/0.60 =1666
Well, using share prices you can clearly see that the index doesn't go up nearly as much this way, because under a market capitalisation weighted system, the smaller companies like company 3 don't have as much effect on the overall index.
Problems:
You'll find that there are plenty of boring people (like me) who'll debate the merits of both of these systems, but it's worth pointing out that most indices globally are market capitalisation weighted.
This also means that you can't compare the FTSE 100 directly with the DOW 30, because they each have different numbers of component stocks and they're calculated differently (this being said they'll still roughly track each other).
Also, when looking at these indices over long periods of time you need to remember that a reasonable amount of the change you'll be looking at will be inflation.
Further to this, companies move in and out of indices in the UK every quarter, so you may not even be looking at the same companies as before.
Index Entry Criteria:
1. Size:
- For entry into the FTSE 100, for example, you would need to be within the top 100 companies in the UK based on your market capitalisation.
2. Purple Book Rules:
- This is based around the idea that you need to provide more information than other companies and that you're subject to providing that information more often than non-listed companies are.
3. High Free Float
- This works on the basis that you can't float a company if no one can buy shares in it, so in the UK for example you're required to have a free float of at least fifty percent of your total shares in issue.
Construction:
Logically, you'll see that if you can map the top one hundred companies by market capitalisation, you can in theory map other ones based on their size and this is how we get the FTSE 250 (the next 250 companies after the FTSE 100 by market capitalisation - not the FTSE 100 plus another 150 companies), FTSE 350 (FTSE 250 + FTSE 100), AIM, etc.
All the best,
The Masked AIM Trader
No comments:
Post a Comment