Subject 3. Uses of Market Indices

Security market indices are used:

  • For predicting future market movements by technicians. Technicians believe past price changes can be used to predict future price movements. For example, to project future stock price movements, technicians would plot and analyze price and volume changes for a stock market series like the DJIA.

  • To measure market rates of return in economic studies.

  • As a proxy for the market portfolio of risky assets. When calculating the systematic risk of an asset, it is necessary to relate its returns to the returns of an aggregate market index that is used as a proxy for the market portfolio of risky assets.

  • As benchmarks to evaluate the performance of professional money managers. A basic assumption when evaluating portfolio performance is that any investor should be able to experience a rate of return comparable to the market return by randomly selecting a large number of stocks from the total market. Therefore, a stock-market index can be used as a benchmark to judge the performance of professional money managers.

  • To create and monitor an index fund or an exchange-traded fund (ETF). An index fund is created to track the performance of the specific market series (index) over time.

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