Question

Indexes are grouped into three major groupings. Please describe these groupings and discuss the major indexes that fall into each group? Also, describe how indexes are used in investment decisions.

Answer 1

Answer-

The three major groupings of indexes are

1) Market-capitalization weighted indexes or value - weighted index
2) Price-weighted index
3) Equal - weighted index

The examples of Market-capitalization weighted indexes are Standard and Poor's (S&P) 500 Index, the Wilshire 5000 Total Market Index (TMWX) and the Nasdaq Composite Index (IXIC).

The examples of Price-weighted index are  Dow Jones Industrial Average (DIJA), Nikkei 225

The examples of Equal weighted indexes are Value line composite average and Financial times ordinary share index.

A market capitalization-weighted index or value-weighted index is based on the market capitalization of each stock in index as a proportion of the total market capitalization of all the stocks that are part of index.

An equal-weighted index is the arithmetic average return of the stocks for a given time period that are compared with  the returns on a portfolio that had equal dollar amounts invested in each index stock.

A price-weighted index is an arithmetic average of the prices of the stocks included in the whole index.

The investment decisions are based on overall performances of indexes and are also based on industry of of the traded stock and its peer companies and whether the stock are overvalued or undervalued.