The Perils of the Immediacy Trap and Why we can and cannot do without it
February 12, 2025
Bank runs have been part of the banking industry for a long time. This is an unintended consequence of the fractional reserve banking system which is followed by the banking industry across the globe. Bank runs were common during the 1920s when the Great Depression took place. However, with the passage of time, the banking […]
Most of the investment banks in existence today have been around for several decades. For much of this time, the investment banking industry has been a haven for unprecedented growth. The industry has seen many risky practices to evolve periodically. This is why the investment banking industry has often been under the scrutiny of the […]
Over the years, corporate banking has become a very important part of the overall banking system. This is because of the fact that banks derive a bulk of their profits from their commercial or corporate banking divisions. Now, the reason that banks derive a larger than usual percentage of their revenue from their commercial banking […]
Depreciation is an important concept in capital budgeting. This is because it is a non cash expense and ideally should not have any effect on the cash flows. This is the reason why it is added back during cash flow calculations. Since the amount of depreciation never actually left our bank account in the form […]
If you have regularly observed the stock market, you may have noticed that a lot of time when the market falls, experts attribute this fall to profit booking. The concept of profit booking is known to a lot of people. However, the knowledge is merely superficial. In this article, we will have a closer look […]
Stock market indices are ubiquitous. People come across these indices almost every day. However, many are not aware about their existence.
For instance everyone knows about NYSE, NASDAQ, FTSE, NIFTY etc. However, few are aware that they are referring to stock market indices when they talk about the markets going up or down. The New Stock Exchange is just an exchange. It does not rise or fall in value.
The indices calculated based on the data aggregated by New York Stock Exchange are what everyone seems to be referring to all the time.
In this article, we will provide a basic introduction of market indices. This will equip the reader to understand what these indices are and why they are important.
Market indices are merely statistical indicators. In financial markets, they are designed to let the people compare the performance of a portfolio of securities. This portfolio could represent an entire market or a particular segment of the market like banking, oil and gas etc.
The index can be easily created because the Pareto principle applies to financial markets. This means that only 20% of the companies that are listed account for more than 80% of the value on the stock exchange.
Hence, these indices only track the movements of a handful of companies in the market. Since these companies broadly represent the market the performance of the entire market can be gauged from their performance.
Index values only make sense when compared to a base value. The base value could be a previous day’s value or it could be the value from many years ago. Usually the base value of an index is 100. The base value, along with the base year, need to be known in order to determine the compounded annual growth rate at which the securities have been growing.
Indices can be used for many purposes. Some of them have been mentioned below.
To know whether a stock outperformed the others, it is essential that the growth of the stock be known and the growth in the relative index be known.
A stock cannot said to have outperformed even if it grew by 20%. If the index grew by 25% during the same period, a 20% growth would instead be considered a lackluster performance.
A stock is said to be more or less risky in comparison to other stocks in the market. Data is collected which compares the risk of the stock vis-a-vis the indices. This data is then converted into a statistical measure called “beta” which is the universal measure of riskiness.
Market indices must have certain characteristics. The important ones have been listed below:
Indices can be created based on multiple methodologies. In the next article, we will study some of the methodologies that are used to construct these indices and how they affect the outcomes of those indices.
Your email address will not be published. Required fields are marked *