Question: Peter Tanaka is interested in starting a stock portfolio. He has heard many financial reporters talk about the Dow Jones Industrial Average as being a proxy for the overall stock market. From visiting various online investment sites, Peter is able to track the variability in the DIJA. Peter would like to develop an average or index that will measure the price performance of his selected portfolio over time. He has decided to create a price-weighted index, similar to the Dow, where the stocks are held in proportion to their share prices. He wishes to form an index based on the following 10 high-quality stocks and has designated October 13, 1980, as the base year. The number of shares outstanding has remained constant over the time period 1980 through 2016. The implication is that the closing stock prices will behave just like the closing market values. Given the data below, create a spreadsheet to model and analyze the use of an index.
a. The divisor is 1 on October 13, 1980, 0.75 on October 13, 2012, and 0.85 on October 13, 2016. Using this information and the data supplied above, calculate the market average, using the same methodology used to calculate the Dow averages, on each of the three dates- October 13, 1980, 2012, and 2016.
b. The DJIA is the most widely cited stock market indicator, yet there are criticisms of the model. One criticism is that the higher-priced stocks in the portfolio will impact the Dow more than the relatively lower-priced stocks. Assume that Stock J increases by 10%. Recalculate the market averages on each of the three dates.
c. Next, assume Stock J is back to its original level and Stock B increases by 10%. Recalculate the market averages on each of the three dates. Compare your findings in all three scenarios. Do you find support for the criticism of the Dow? Explain.