What’s an Index?

An Index is a number used to represent the changes in a set of values between a base time period and another time period.

What’s a Stock Index?

A Stock Index is a number that helps you measure the levels of the market. Most stock indexes attempt to be proxies for the market they exist in.

Returns on the index thus are supposed to represent returns on the market i.e. the returns that you could get if you had the entire market in your portfolio.

Why do we need an Index?

Students of Modern Portfolio Theory will appreciate that the aim of every portfolio manager is to beat the market.

In order to benchmark the portfolio against the market we need some efficient proxy for the market.

Indexes arose out of this need for a proxy.

What does the number mean?

The index value is arrived at by calculating the weighted average of the prices of a basket of stocks of a particular portfolio.

This portfolio is called the index portfolio and attempts a high degree of correlation with the market.

Indexes differ based on the method of assigning the weightages to the stocks in the portfolio.

But why a portfolio? Why not the entire market?

This is because for someone who wishes to replicate the return on the market it is infinitely more expensive to buy the whole market and for small portfolio sizes it is almost impossible.

The alternative is to choose a portfolio that has a high degree of correlation with the market.

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