What indexes are and the information they provide
This guide explains what indexes are and the information they provide.
This guide also explores how indexes are used, both as benchmarks for investment performance and as the basis of several popular investment products - EFTs, index mutual funds, and index-based options and futures contracts.
Tracking securities markets
an index provides a continuously updated record of financial market performance
An index tracks the prices of a specifically selected group of securities to measure the performance of the financial market or market segment to which the securities belong.
A financial market can be defined in a variety of ways—by asset class, security size, risk level, geography, and a variety of other factors. For example, an index might track large-company US stocks, corporate bonds issued in developing markets, or global oil prices, to name just a few.
An index can be broad—tracking hundreds or sometimes thousands of securities—or narrow—tracking only a few—or somewhere in between.
But what each of an index’s components must have is a publicly available market price. Without a price, there can be no calculation. And if the price isn’t publicly available, there’s no way to be sure that the index is objective and therefore a reliable indicator of performance.
Constructing an index
crafting an index begins with making some critical decisions
An index doesn’t just happen. It’s created by an index provided to meet one or more objectives, such as providing a benchmark, serving as the basis of a financial product, or both.
Having identified the index’s purpose and determined that it can be calculated, the provider can begin to develop its methodology, which involves:
Defining the index’s focus and scope
Identifying the securities that will form its portfolio
Determining how the index will be weighted
Setting the criteria for changing the components of the index and how those changes will be made
Deciding how it will be calculated