Definition

An index is a numerical figure which measures relative change in variables between two periods.

 Examples

If sales in year 2000 are equal to Kshs.25 M and for year 2001 Shs.30 M, the sales index would be as follows:

 Sales index = year 2001 sales = Shs.30 M x 100 = 120

Year 2000 sales Shs.25 M

 Year 2001 sales are 120% of year 2000 sales, year 2000 is called Base year.

 A stock index therefore measures relative changes in prices or values of shares. The NSE has its base year as 1966. 20 companies constitute the index.

 The stock index is computed using Geometric mean (G.M) as follows:

 Todays stock index = (Today’s share price G.M)² x 100

Yesterday’s share price G.M.

 Where G.M =

 Where G.M. P₁ x P₂ x P₃ x P₄ ------- P_n = share price of companies that constitute stock index.

  N = number of companies

• When stock prices are rising, stock market index will rise and vice versa.

• Stock market index therefore is an indicator of investors confidence in the economy.

Illustration

The following 6 companies constitute the index of democratic republic of Kusadikika.

Compute the stock market index for today.

In construction/computation of stock index the following should be considered:

1. Choice of base year on which to base the price changes

2. The selection of representative securities/firms

3. Combining the securities/firms to construct the index eg use of geometric mean

4. Use of suitable weight to be attached to the securities depending on their relative importance.

5. The weights/number of firms in a sector is kept constant over a reasonably long period.