Stock Market Indices
A stock index is a numeric value that is used to indicate the value of a particular portion or segment of the stock market. It is computed by calculating the prices of certain stocks which are picked up on a defined criterion or index. This index is used by investors and financial advisors to guide the people in investing their money wisely. The Indexes are of various types and are based on the certain parameters.
Table of Content
Dow Jones Industrial Average
It is an index that represents the change in the average prices of 30 large-scale organisations belonging to different industries of the United States. It is also called Dow Jones or Dow 30 or the Dow.
The S&P 500 Index
It is the benchmark that is mostly used by the large-cap segment of the local stock market of USA. It is also called the S&P 500 or the market. In this index, around 500 USbased companies are included that cover almost 75% of the total US equity market. Most of the investors include the best S&P 500 Index funds in their mutual funds portfolio as their core assets.
NASDAQ
It is a stock exchange that is considered to be the successor of Over-The-Counter (OTC) system of trading. NASDAQ is different from the NYSE as it has a fully automated network as it is the first electronic trading system. In addition, it is known for its high concentration of stocks of technology sector as compared to other stock exchanges.
National Association of Securities Dealers Automated Quotations (NASDAQ) is one of the most popular stock indexes and one of its main indexes is NASDAQ Composite with over 3,000 stocks. However, NASDAQ 100 is supposed to be the best known index of NASDAQ. The stocks are traded on NASDAQ with ticker symbols consisting four characters. For example, the shares of Microsoft are traded with the ticker symbol MSFT while Twitter shares are traded as TWTR on the NASDAQ stock exchange.
Wilshire 5000 Index
It is considered to be the total stock market index as it is the broadest index having more than 5000 stocks that depict a complete range of market capitalisation (which includes large-cap, mid-cap and small-cap segments). In Wilshire 5000 index, the large-scale companies having larger capitalisation will represent larger portion in terms of percentage than the smaller companies having less capitalisation. Thus, it is called the market-cap weightage index.
Russell 2000 Index
It is an index that acts as a representative of the small-cap stock portion of the equity investment in the stock market. This index has around 2000 stocks of the smallest companies on the basis of market capitalisation. According to Russell Investments, the Russell 2000 Index “is constBarclays Capital Aggregate Bond Index: It is a broad bond index that includes most of the bonds traded in US as well as some foreign bonds.
This index is also called the BarCap Aggregate or the Agg.ructed to provide a comprehensive and unbiased small-cap barometer and is completely reconstituted annually to ensure larger stocks do not distort the performance and characteristics of the true smallcap opportunity set.”
MSCI
Morgan Stanley Capital Investments (MSCI) Indexes have various indices that act as a benchmark for judging the performance of the foreign stock portfolio. Some of these indices include MSCI All Country World Index (ACWI), MSCI Europe, Australasia, and Far East (EAFE), MSCI World, and MSCI Acronym Suffixes. MSCI ACWI consists of more than 9000 securities including large, mid, and small-cap size segments in 45 developed and developing markets.
MSCI EAFE includes indices of 21 individual countries that together represent most of the major markets of the world. MSCI World has more than 1,600 securities of developed countries around the world. In MSCI Acronym Suffixes Index, if the index name includes acronym IL, it implies that the index is listed in the local currency while an acronym DM in the index represents Developed Markets and EM is an acronym of Emerging Markets.
Bond Indices
Bond index is computed on the basis of bonds selected according to certain parameters. The bond index assists the investors in deciding the future course of action on the money they have invested. In the case of financial markets, an index is a fictional portfolio of securities representing a particular market or a portion of it.
Each index has its own calculation methodology and is usually expressed as a change from a base value. Therefore, the percentage change is more important than the actual numeric value. Stock and bond market indexes are used to construct index mutual funds and Exchange-Traded Funds (ETFs) whose portfolios reflect the components of the index.
Some of the bond indices are discussed as follows:
Barclays Capital Aggregate Bond Index
It is a broad bond index that includes most of the bonds traded in US as well as some foreign bonds. This index is also called the BarCap Aggregate or the Agg.
Salomon Broad Investment Grade (BIG) Index
It is a commonly used American bond index, which is owned by Salomon Brothers and now is handled by Citigroup. Thus, this index is also called Citigroup BIG. This index is used for managing broad debt portfolios having long-term as well as short-term maturity dates. It includes bonds like treasuries, agency debt, corporates, non-corporate credit, mortgage-backed securities, and Asset-Backed Securities (ABS).
Merrill Lynch Domestic Master
It is an American Bond index owned by Merrill Lynch. It is same as the above two bond indices, i.e. Salomon BIG or Barclays Capital Aggregate Bond Index. It is the part of the Merrill Lynch US Broad Market (US00). It includes bonds like public corporate and government debt, treasuries, mortgage-backed securities, global bonds, and some Yankee Bonds. However, it does not include asset-backed securities (ABS), tax-exempt municipal debt, 144As and any bond without a fixed coupon schedule, etc.
JPMorgan Emerging Market Bond Index (EMBI)
It includes three bond indices for tracking bonds that are traded in the emerging markets. This index is owned and operated by JP Morgan. The EMBI index includes bonds like Brady bonds (U.S.Dollar denominated bonds), loans and Eurobonds. The bond indices included in JP Morgan EMBI are Emerging Markets Bond Index Plus, the Emerging Markets Bond Index Global and the Emerging Markets Bond Global Diversified Index.
Investing in Financial Assets
A financial asset is an asset whose value is based on some contractual entity. For example, stocks, bonds, bank deposits and other instruments are financial assets and have a legal identity.
Investing in financial assets requires careful consideration of the following factors:
- Risk Involved: Some financial assets have a very high risk associated with them. Any wrong decision can lead to heavy losses for the investor
- Market Dynamics: Market dynamics such instable government, new tax structure, etc., can have a positive as well as negative impact on the financial market.
- Nature of Economy: An open or closed economy impacts the financial market differently.
- Impact of Global Forces: The financial markets may be influenced by the happenings in the world.
Trading Mechanic
Trading mechanics is the process of buying and selling of stocks from stock exchanges. Trading mechanics involves the following steps:
- Place an order: To buy or sell shares, an investor needs to place an order through a broker member. The broker enters the price and volume of shares that the investor wishes to buy or sell.
- Order match: Trades are automatically matched at the best bid/ offer price already on the system. Once the orders are matched, a trade notification is sent to both the buying and selling brokers, with the details of their side of the trade and the details of the counterparty that they are required to settle against. The best buy order matches with the best sell order. An order might match partly with another order resulting in multiple trades. In order matching system, the best buy order is the one with highest price and the best sell order is the one with lowest price.
- Breaking up of orders: Orders can be broken up on the order system at the same or at different prices. The visibility of orders can be withheld so that the order to buy or sell the next block of shares is not placed live on the system until the existing order has been matched.
- Modify orders: Orders to buy and sell can be added, modified or removed from the trading system at any point during market hours. However, once matched, the bargain is instantly sent for settlement between the brokers on behalf of the investors.
In India, the trading in the stock market takes place on two stock exchanges, namely the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE). Both of these stock exchanges follow same trading mechanism, trading hours, settlement process, etc. All the important and significant organisations of India are listed on both of these exchanges. Trading at both BSE and NSE takes place using an open electronic limit order book.
This book is used for matching orders with the help of the trading computer. This electronic system has removed the market makers or specialists from the stock markets and the whole process has become order-driven, which implies that the market orders placed by the investors can be matched automatically with the best limit orders.
Such a market helps in bringing all the orders placed delete in the trading system. The orders are placed by brokers in the trading system. Most of these brokers provide online trading facility to retail customers. The institutional investors can use the Direct Market Access (DMA) option that allows them to place orders directly in the trading system through the use of trading terminals provided by brokers.
Now let us study the trading mechanism of some securities and assets.
Equity Trading
It refers to the purchase and sell of an organisation’s stock shares. In case of large companies, the equity trading takes place through the stock exchanges like New York Stock Exchange, Bombay Stock Exchange, etc. These exchanges act as managed auctions for stock trades. On the other hand, small companies trade their shares in Over-The-Counter (OTC) markets, which are the markets in which the securities of those companies are traded that are not listed on the stock exchanges.
Equity trading is performed by an individual/organisation himself or through the broker or agents, who buy or sell shares on behalf of the individual/organisation. These brokers or agents are paid a commission by the individual on whom behalf the broker is performing the trade. Equity trading is done 24*7 days and 365 days of a year and thus, contributes a large part in the growth and development of an economy.
Derivative Trading
It involves the trading of various derivatives like spot, futures, forwards, options, and swap in the FOREX market. The FOREX market includes a set of institutions like commercial banks, central banks, investment bankers, MNCs, hedge funds, dealers, brokers and retailers. In the FOREX market, the currencies traded by individuals or organisations through a network of banks, which is called inter-bank trading. All the banks associated in the network are also involved in the trading process using Electronic Broking System (EBS).
EBS is a system in which transaction of currencies takes place by quoting a currency against another currency. The currency which is used for quoting is called quote currency and the currency against which it is quoted, is called ‘base’ or transaction currency. Such transactions are performed 24 hours a day and 5.5 days in a week (i.e. Monday to mid-Saturday). In equity spot market, the T+2 rolling settlement is followed for settlement purpose. In T+2 rolling settlement, any trade or transaction taking place on Monday will be settled by Wednesday.
