Microsoft Office Tutorials and References
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Case 12: The Brewery Index Calculation
(issued to investors), and its current price is $10
per share. Company B has 2,000 shares outstanding, with a current price of $8 per share. Company C has
3,000 shares outstanding at a price of $12 per share. One way to compute an index for these three
companies would be to average the prices, which would result in an index of 10 (30/3).
Note that such an index would be
Company A has 1,000 shares of its stock
in other words, each company would be treated equally
in the averaging process. However, the market
(the number of shares multiplied by price per
share) are not the same. Company C has $36,000 of stock outstanding, B has $16,000, and A has $10,000.
Stock market indexes generally are weighted by capitalization. The capital weighted index for companies
A, B, and C would be calculated as shown in Figure 12-2.
Capital weighted index calculation
The Product column shows the market value for each company. Total market value ($62,000) divided by
total shares (6,000) yields an index of 10.33. The effect of a share price change is shown in Figure 12-3.
Index change caused by price change
s price rose by a dollar, causing the index to increase slightly. Of course, if the price had
declined by a dollar, the index would have declined slightly.
A change in shares outstanding can also change the index value, as shown in Figure 12-4.
Index change caused by change in shares outstanding
In the figure, company B issued 2,000 more shares, also valued at $8. Company B
s relatively lower price
is now more heavily weighted, moving the index lower.
In recent years, mutual funds have created funds that mirror well-known stock indexes. For example,
some funds track the S&P 500 index. Such funds are a collection of stocks in the same ratios as the index.
A company that manages this type of fund will buy and sell shares of a stock as its capitalization changes in
the index. Therefore, the value of the fund tracks the value of the index.
Some investors think that the value of the overall market will increase over time, but that it is difficult to
predict changes in the value of individual stocks. People who want to invest in the market as a whole are
attracted to index-based funds.
If there were a brewery index, the regional exchange managers think that a mutual fund company might
create a fund that tracks the index. The exchange managers believe that such a mutual fund would be