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Sem 5 Prep
← Money & BankingThe secondary market, indices and efficiency

Formulas for this chapter

Price-weighted index

Index = SUM(prices) / divisor New divisor after a corporate action = new price sum / index level to be preserved

When the question gives only prices. The divisor starts as the number of stocks and must be re-solved after any split or constituent change.

prices
Market price of each constituent
divisor
Initially the number of stocks; adjusted to keep the index continuous

Value-weighted index

Index = (SUM(price x shares) / base market cap) x base index value Shortcut: New index = Old index x (new aggregate cap / old aggregate cap)

The method the Sensex and Nifty use. Needs share counts as well as prices, and requires no adjustment for splits.

price x shares
Market capitalisation of each constituent
base market cap
Aggregate capitalisation on the base date
base index value
Index level assigned to the base date, e.g. 100 or 1,000

Equal-weighted index return

Return = (SUM of individual percentage returns) / number of stocks

When every constituent is to count the same. It over-weights small companies relative to the market and needs periodic rebalancing.

individual return
(new price - old price) / old price, per stock
Step 1 of 23
The ideaTheory

The exit door

Nobody would buy a twenty-year bond or a share in a company if they could never sell it.

The secondary market is the exit door. Its existence is what makes people willing to walk through the entrance.

So the primary market raises the money, but the secondary market is what makes the primary market possible. Everything in this chapter follows from that: the exchanges that provide the door, the indices that measure what is happening inside, and the question of whether prices there are worth trusting.

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