WEBVTT 00:00.950 --> 00:07.000 Welcome to the section on financial index this and this and the next videos you will learn the fundamentals 00:07.000 --> 00:13.060 of financial indexes and in particular stock indexes and you will understand not only the importance 00:13.060 --> 00:19.270 of indexes and why index funds are heavily used in the investment industry but and so this is still 00:19.270 --> 00:20.760 a python coding costs. 00:20.830 --> 00:25.720 You will have the opportunity to create your own customized the stock index. 00:25.720 --> 00:32.590 And finally we will also elaborate on the choices and truth and index construction and learn the pros 00:32.590 --> 00:36.140 and cons of different index types. 00:36.130 --> 00:36.720 All right. 00:36.760 --> 00:42.730 And even if you have no detailed knowledge on financial indexes I am pretty sure that you get in touch 00:42.730 --> 00:45.260 with indexes almost every day. 00:45.400 --> 00:47.500 When you read the news. 00:47.500 --> 00:53.460 So for example you can see headlines like U.S. stocks mixed at close of trade. 00:53.500 --> 00:57.660 Dow Jones Industrial Average down 0 point 0 4 percent. 00:57.730 --> 01:00.160 So what does this headline tell us. 01:00.250 --> 01:02.130 And instead of listing all U.S. stocks here. 01:02.150 --> 01:04.910 So we have a few thousand stocks actually. 01:05.050 --> 01:07.600 They simply say that the Dow Jones is down. 01:07.600 --> 01:09.260 0 point 0 4 percent. 01:09.490 --> 01:17.080 And the Dow Jones Industrial Average actually an index and kind of measures aggregates last summarizes 01:17.410 --> 01:24.100 the performance of U.S. stocks and actually one number here and there actually are many examples of 01:24.220 --> 01:27.910 financial indexes or in particular stock indexes. 01:27.910 --> 01:34.870 So we have here the Dow Jones Industrial Average which actually measures the performance of 30 large 01:34.970 --> 01:36.160 U.S. stocks. 01:36.250 --> 01:43.510 Then we feel the S&P 500 which aggregates and measures 500 large U.S. stocks. 01:43.680 --> 01:44.190 We have here. 01:44.200 --> 01:49.630 The Nasdaq composite which is actually heavily weighted towards tech stocks. 01:49.690 --> 01:57.240 Then we have the Nikkei 225 which contains 225 large Japanese stocks. 01:57.400 --> 02:01.470 Then we feel the Euro stocks 50 year with 50 a lot. 02:01.480 --> 02:11.380 European stocks and also we fear the attacks 30 which includes 30 large German stocks and actually many 02:11.380 --> 02:19.880 more indexes not only a stock indexes but also fixed income while bond indexes and commodity indexes. 02:19.880 --> 02:23.290 So that's actually no restriction on that here. 02:23.290 --> 02:27.850 So why do we use indexes and why are indexes there useful. 02:28.420 --> 02:34.330 And we've already learned that an index represents aggregates and measures the performance of an asset 02:34.330 --> 02:37.590 class and an asset class can be actually everything. 02:37.590 --> 02:44.230 So for example bonds or commodities and you know examples that we have seen an asset class can also 02:44.230 --> 02:46.280 be a stock market segment. 02:46.420 --> 02:55.060 For example U.S. large cap and large cap actually stands for large capitalization and actually the market 02:55.060 --> 03:00.100 capitalization is nothing else than the equity value of a company. 03:00.460 --> 03:07.390 So the segment the US the large cap simply includes the large U.S. companies in terms of market value 03:07.750 --> 03:11.650 and there's actually no limit to narrow down the segment definition. 03:11.650 --> 03:18.580 So we could also say U.S. large cap in the finance and receive for example then as a second point indexes 03:18.610 --> 03:22.720 are heavily used as model portfolio our benchmark. 03:22.720 --> 03:28.570 And typically small investors that wish to invest in the broad market but they're actually unable to 03:28.570 --> 03:36.070 invest in 50 or 100 separate stocks and therefore we have the funds industry that creates mutual funds 03:36.130 --> 03:44.620 or exchange traded funds ETF and these funds actually use indexes as Model Portfolio benchmark to create 03:44.650 --> 03:46.810 and define their funds. 03:46.810 --> 03:53.280 And those fund managers try to match or to track the performance of the index as close as possible. 03:53.320 --> 03:59.530 So typically the fund managers advertise that their funds by saying that for example the fund is closely 03:59.530 --> 04:07.000 tracking the S&P 500 and by investing only in this fund investors actually invest in 500 large U.S. 04:07.000 --> 04:15.060 stocks and finally indexes also serve as a performance benchmark to evaluate historical investment performance. 04:15.100 --> 04:16.260 So exposed. 04:16.280 --> 04:20.240 The question is always did the fund to beat the benchmark or not. 04:20.290 --> 04:27.040 And let's assume we have a fund that claims to track the S&P 500 and in the last year it showed a positive 04:27.040 --> 04:29.890 return of 10 percent which is actually great. 04:29.890 --> 04:35.320 But this has to be compared to the performance of the S&P 500 index. 04:35.560 --> 04:43.210 And if the benchmark which is in this example the S&P 500 returned 15 percent in the same period then 04:43.270 --> 04:46.020 the fund manager that's actually a pretty poor job. 04:46.390 --> 04:46.870 All right. 04:46.870 --> 04:54.790 These are the main use cases of financial indexes and the rationale behind indexes and the next question 04:54.790 --> 04:57.220 would be how to create an index. 04:57.220 --> 05:01.150 And there are several options or choices that we have to consider. 05:01.280 --> 05:08.810 And in total we have actually five steps and the very first step is actually to define the target market 05:08.960 --> 05:11.930 which our index should cover our aggregate. 05:12.290 --> 05:14.710 And as I said before there is actually no limit. 05:14.710 --> 05:18.110 So the target market can be very broad. 05:18.110 --> 05:21.800 So for example U.S. stocks but it can also be very narrow. 05:21.800 --> 05:28.670 So for example the segment the US the large cap finance and once you have defined the target market 05:28.680 --> 05:35.630 or target segment then the question is which securities to include in our index. 05:35.630 --> 05:42.350 And first of all we have to identify the securities in our segment and as a second step We have to select 05:42.350 --> 05:50.160 the securities that we want to include into our index and these securities the so-called constituents 05:50.210 --> 05:57.620 of the index and typically they are fundamental and measurable criteria to select their constituents. 05:57.630 --> 06:05.310 So for example the market capitalization but in most cases they are also soft facts that are evaluated 06:05.310 --> 06:06.420 by a committee. 06:06.900 --> 06:11.720 So let's go to the next step and let's assume that we have selected their constituents. 06:11.820 --> 06:15.360 Then the next question would be how to wait. 06:15.390 --> 06:22.590 These constituents and our index and they actually three major methods how to weight the constituents. 06:22.680 --> 06:25.310 So we have price weighted indexes. 06:25.320 --> 06:29.340 Then we have equal rated indexes and value weighted indexes. 06:29.490 --> 06:37.230 And in the next videos we will examine those methods in detail but then we have the next step. 06:37.320 --> 06:39.180 It's the index return. 06:39.180 --> 06:46.830 And here we have to define whether our index should be a price return index or a total return or performance 06:46.860 --> 06:47.960 index. 06:48.090 --> 06:53.820 And the difference is simply that a price return index does not contain dividends. 06:53.940 --> 06:58.660 So typically the total return of a index and also of a stock consists of. 06:58.740 --> 07:01.900 The price return or price increase or decrease. 07:02.100 --> 07:08.190 And the dividend payments and a total return or performance index includes both. 07:08.190 --> 07:14.940 And in contrast the price return index excludes actually dividend payments and actually for the large 07:14.940 --> 07:18.630 and very unknown indexes both the variance exists. 07:19.080 --> 07:24.000 But uh there's always one variant that is more prominent actually. 07:24.210 --> 07:30.450 So for example if somebody is talking about the Dow Jones industrial average then you typically means 07:30.500 --> 07:32.830 the the price return index. 07:32.880 --> 07:38.340 And finally once we have defined and created our index there are some ongoing things to do. 07:38.340 --> 07:45.240 So for example we have the rebalancing and you have to define how and when to rebalance the weights 07:45.420 --> 07:48.960 that can actually drift apart from the target weights. 07:49.020 --> 07:55.950 And second we have also the reconstitution and the question is the R when and how to reconstitute the 07:55.950 --> 08:00.250 index and uh to change the constituents in the index. 08:00.360 --> 08:04.630 So that's actually the five major steps of index construction. 08:04.710 --> 08:06.570 And so this is CIA cutting costs. 08:06.570 --> 08:12.060 We will focus on the technical steps so the waiting and the return. 08:12.780 --> 08:16.800 And finally I would show you some examples of indexes here. 08:16.800 --> 08:24.070 So we have here the Dow Jones Index which uh covers actually a 30 large U.S. stocks and the rating is 08:24.070 --> 08:25.430 actually price weighting. 08:25.440 --> 08:32.580 And uh typically and we are talking about the Dow Jones index that's uh the price return index but also 08:32.580 --> 08:34.800 the total return index success. 08:34.890 --> 08:40.680 Then we have here the Nikkei 225 which covers 225 large Japanese stocks. 08:40.680 --> 08:47.640 And uh we have here actually a price weighting and that's actually a price return index. 08:47.640 --> 08:51.440 But also here the total return index exists as well. 08:51.510 --> 08:54.060 And then we have also the Euro stocks 50 and next. 08:54.060 --> 09:00.860 And the tax 30 index and those two indexes are actually of value weighted index us. 09:01.320 --> 09:06.800 And if you talk about the tax 30 then you typically mean the total return index. 09:06.870 --> 09:08.840 So these are for index examples. 09:08.850 --> 09:13.170 And uh with this we are finished here and I hope to see also in the next video by.