 Hello and welcome to the session. This is Professor Farhad and this session we would look at market value weighted index in contrast to what we looked earlier at the price weighted index. So now we're going to look at market value weighted index and here we are talking about the S&P 500 NASDAQ NYSE. This topic is covered in essential of principle of investment course or principles of investment course, whether it's a graduate or undergraduate. As always, I would like to remind you to connect with me only then if you haven't done so, YouTube is where you would need to subscribe. I have 1,700 plus accounting, auditing, tax, finance, as well as Excel tutorial. If you like my lectures, please like them, share them. If they benefit you, it means they might benefit other people connect with me on Instagram. On my website, farhadlectures.com, you will find additional material to supplement your accounting as well as your finance education, especially if you are studying for your CPA, CFA, enrolled agents, CMA exam. I strongly suggest you check out my website. So let's take a look at the S&P index and this is also very much highly looked at index. Just like the DAO, we talked about the DAO, the DAO 30, this is 500. So this S&P 500 index represent major improvement over the DAO in two ways. One, it's obviously, it's rather than only looking at 30 companies. We're going to be looking at 500 companies to gauge the performance of the stock market, which in turn gauge the performance of the economy. That's the idea of the index is by looking at one number, you would see what's going on in the economy. Now that is true that the S&P include 500 companies versus the DAO, but you will see later when we're going to be looking at the actual weighting of the S&P. It's a little bit misleading and we'll talk about that shortly. The other thing is it's market value weighted index versus price weighted index. When we talked about the DAO, when we talked about the DAO, the DAO is a price weighted index. This is market value. So the index return equals to the weighted average of the return of each component security, which is it's weighted proportionally to the outstanding market value, which has taken the price of the stock times the outstanding shares. Don't worry, we're going to work an example. But the first thing you want to understand the difference between the S&P and the DAO, the S&P is market value weighted index, not price, not based on the price of the stock, it's based on the size. And how do we measure the size? The price of the stock times how many shares? So if the price goes up and you have a lot of shares, you're going to weigh more. So you need both of these to be high to weigh more. So this is a snapshot of what the S&P looks like. This is only 23 companies that include 500 companies. But the point I'm trying to make here is look at the S&P. If we look at Microsoft, Microsoft represent almost 6% by itself. Apple represent 5.7. So notice between Microsoft and Apple alone, those two companies represent 10% of the index. Although it includes 500 companies, two companies take 5%. If we look at Amazon, Amazon represent for almost five. So we're up to 15%. So notice three companies, three out of 500 companies taken over 15. If we add Facebook, Google, which is alphabet, both alphabet, a class A and class B, we're talking now 20%. So notice 20%, 20% of the 500, only five companies. Five companies basically, one, two, three, four. Yeah, five companies represent 20%. And the remaining 495 companies, they represent 80%. So just something to think about. So although it's 500 companies, but it's dominated by few companies. And that's very important for you to understand this because just those are trillion companies. That's why they weigh so much, their price went up and value so high. Other US market value indexes, we have the NYSE and we have the NASDAQ. The NYSE is the New York Stock Exchange publishes a market-valuated composite, the same concept. In addition, it has subcomponents for industrial, so the industrial industries, utilities, transportation and financial stocks. And by the way, the transportation index of the NYSE is highly looked at to know what's going on in the economy. So it's a major indicator when the transportation index is slowing down. NASDAQ also, it's a very important index. Basically, NASDAQ is a market and an index. Also compute the index of more than 3,000 firms traded on the NASDAQ. And again, as of March 15, 2020, this is not the date of this recording, but this is basically, I just wanted to give you an idea about what the index include. 48% technology, 14 to almost 20% consumer index, healthcare, financials, industrial. The point is it's dominated by technology companies. So when you think about the NASDAQ, think of technology. Half of it is in technology. Then we have the NASDAQ 100 as a subset of the NASDAQ. And this one is tech heavy. This one is tech heavy. So when we say the NASDAQ 100, it means we are talking about tech companies. And this is a picture. Let me show you who dominates the tech at the NASDAQ 100, which is no surprise. You're going to find out that these are the same companies that dominated the S&P 500. Apple, Apple represent 12% of the NASDAQ 100 by itself. It's 100 stocks, Apple by itself 12, Microsoft almost 12, together like 25% at Amazon 10. So between Amazon, Apple, Microsoft, and let's add Facebook and Google, 6, 10, wow, almost 50%. You can say almost 50% more or less. 50% of it is dominated by, well, 45. Let's say 45% is dominated by those five companies. Again, here just talking about those heavy weighted stocks, Apple, Microsoft, Amazon, Facebook, and Google. Also, we have a more inclusive US index. It's the largest one is called the Welchire 5000 index, obviously, because it used to include 5000 stocks. Now it includes more or less around 4000 stocks. And those are market value index. So as your stock goes up in value, your stock represent more, it weigh more. So simply put, when Apple's down for its particular day, there's a good chance the whole NASDAQ is down or the NASDAQ 100 is down, because Apple and Microsoft, let's assume Apple and Microsoft, because they represent a large portion of the index. Hopefully this makes sense. And also if Apple's down, remember, when I talked about the Dow, Apple was 300 and some odd dollar, 342. Now it's around 350 today. The point is Apple is a heavyweight stock. And simply put whatever you use it in the NASDAQ and the Dow and the S&P 500, it's heavy weighted. Also, we have what's called equally weighted index. Not we don't have those really, but let's talk about this. An index is computed from a simple average of return. And we don't like simple, basically place an equal weight on each return. So all the stocks, they have an equal return. So it's a simple average. And we would look at an example. So unlike price or market value, equally weighted indexes do not correspond to buy on whole portfolio. Because for you to have an index that's equally weighted, you have to constantly buy and sell. So suppose you start with two equal investments in two stocks. Let's assume you bought two stocks, ABC and XYZ. And when you form the index, you invested 1,000 and ABC, 1,000 and XYZ. So ABC represent 50% and XYZ represent 50%. So they're equally weighted. Now what happened if ABC increased by 20%, ABC becomes 1,200. XYZ decreased by 10, XYZ decreased goes to 900. Now you don't have an equally weighted portfolio. So what you have to do now, you have to rebalance. You have to sell some of ABC and buy some of XYZ to make sure your portfolio is rebalanced. So that's the problem with the equally weighted indexes. They required a lot of work. They just know that they exist. That's basically it. So the best way to illustrate this concept, we're going to take a look at this problem to see how we could compute the price weighted index for three stocks. We have a period zero, period one, period two, and this is the number of shares. What happened to the divisor? We're going to look at what happened to the divisor. We looked at this in the prior session. We looked at the DAO. So we're going to compute the divisor. Calculate the return of the price weighted index. So we're going to look at the price weighted index for the second period, which is period two. And we're going to look at the mark. We're going to compute the same thing for market value evaluated index. We assume it's market value. We're going to assume it's equally weighted index. And you're going to see for each computation, we're going to have a different return. The point is what matters for the index is what are you using? So it's very important to understand what method are you using? Are you using price weighted index? Are you using the market value? Are you using equally weighted? Equally weighted, usually not used, but just something you need to be aware of. So I transferred this data to the Excel sheet. So we're going to look at the Excel sheet to perform those computation. So let's take a look at this Excel sheet. And basically we have the prices. Let's first compute the first, which is the price weighted index. So we're going to first compute the price weighted index for period one. So let's let me, so we're looking at period one. The first thing is period one. So what do we do? We're going to take the beginning period and the beginning period simply put, if we look at the beginning period, we have the three stocks, 95, 50, and 100. Divide them by three. So at the beginning of the period, the index is $80. At the end of the period, we add 95, 45, and 110. The end of the period, $83.33. So the index went up by $3.33. We take $3.33 and we'll divide it by the beginning price of 80. We have, let's turn this into a percentage, just to kind of just make more sense. We have 4.17%. So the return is 4.17% on this portfolio. Now let's go back to the PowerPoint slides. They told us in the calculated rate of return on the price-weighted index of the three stocks, what happened to the divisor for the price-weighted index. And here's what happened. We're going to assume that we had 2,4,1. We're going to assume that we had 2,4,1 stock split for C. So stock C split 2,4,1. So this stock, this stock here split 2,4,1, 2,4,1. So now we're going to compute the divisor. Again, we did this in the prior session. What happened to the divisor? Well, let's first take a look at what we did, the formula. The formula is, is you take period one, which is the beginning period, the beginning period not, I'm sorry, yes, period one, which is 95, 45, and hold on a second, isn't that 100? No, remember this is 2,4,1. Therefore the price is cut in half divided by D. We have to compute a new divisor. And this should give us the period one, the period one number, which is 83.33, because we have to adjust. So simply put, our, our, our, the value should be the same, but the divisor is going to change. So what's going to happen is we're going to compute the divisor, and we're going to come up with the divisor 2.34. Now how did we compute this? Basically take 95 plus 45 plus 55. Let's do the computation, because I know some of you might be saying just do the computation, this way it's easier for me. So 95 plus 45 plus 55, that's equal to 195, that's equal to 195. So 195 over D, over D, not over 9, equal to 83.33. Now what I'm going to do, it's 83.33 D equal to 195, D equal to 195 divided by 83.33, and that's going to give me 2.34. So the divisor is 2.34. Now also they want us to compute the return in, in period two. The return in period two is zero, because notice the price in period one was 95, the price in period two is 95, the price in period one is 45, the price in period two 45, one 10 split and half became 55. So the price did not change. Therefore the return is zero. But if you really want to make the, the computation, here's the computation. For period one, which is period zero here, we'll take 95 plus 45 plus one 10 divided by three, to find the value of 83.33. For this period, which is for period two, now we're going to have to use the new index, the new divisor for the index, which is, we're going to add 95 plus 45 plus 55, but divide them by 2.34. Notice we'll divide them by 2.34. Therefore the return is zero. Simply put, because the stock split, the return is zero. Okay? The return is zero. Not because the stock split, there was, you know, basically it's, it was adjusted. Now let's compute, this is as a market value index. So how do we compute a market value index? Let me bring this picture down, because it's, you want to see where the numbers are coming from. Now the market value index, it means we're going to take the price times the quantity, that's the value for A, 50 times 200, the value for B, 100 times 200, the value for C. Now we're going to compare this to period two, because this is weighted average. Weighted average means take the price of the stock times the quantity, the number of shares. Well, what's going to happen is this, the value of the portfolio for period one, which is this period here, is 39,000. Notice, this is what I did. I took 90 times 100, 50 times 200, 100 times 200. For period two, that's 40,500. The difference is 1,500. The percentage return is 3.85. So notice the return is different. So when we computed the return, based on the, based on the weighted average, you will see it is different than the price weighted average. Price weighted average gave you 4.17, market value 3.18, and sometimes it's, now it's close to each other, but sometimes they could differ substantially. Okay? Now if we assume we are dealing with an equally weighted average, equally weighted average, it means we're going to compute the price, the price change in stock one, which is went from 90 to 95, went up 5.6%. Notice the difference between 90 and 95, which is $5 divided by 90. The return on stock B, which is went from 50 to 45, went down by $5 divided by 50, $5 divided by 50 equal to negative 10, and C went from 100 to 110, went up $10 for a stock of 100, so 10 divided by 100 equal to 10%. Now what we do is, we're going to take 5.56 plus negative 10 plus 10% divided by 3, give them equal average, 1.85. Notice it's very, very misleading, and here you would need constant allocation if you are doing this equally weighted unpopular average. As always, I would like to remind you to connect with me on LinkedIn, and if you like this recording, please like it, share it. If it benefit you, it means it might benefit other people, and always going to invite you to check out my website farhatlectures.com for additional resources, and if you're studying for your CPA or CMA exam or CFA exam, study hard. Education is worth it. Good luck and stay safe.