What is the underlying value of a market index?

Cuddles

Cuddles

A bit of newbie question here, but I was initially under the impression that an index was much like a mutual fund in that it owned a basket of companies' stocks. Looking at crypto, it now seems to me that it's merely a perception of value of these stocks (at least as originally intended).

In other words, are indexes' worth in providing aggregate value information of the companies that make it?

I understand that as buyers poured money into an index, these in turn could have started to invest in "real" value by acquiring said stocks that make it (akin to a mutual fund) and real estate to run operations, so an index "company" is more legitimate at that point.
 
It varies from index to index. The S&P is market cap weighted, and would be very close to owning each component with a position size as a linear function of its market cap. The Dow, however is price weighted and would be like owning each component as a linear function of its price (so, it's effectively valued by the square of it's component prices). This has been on glorious display the last few weeks in particular, where those two seem totally unlinked in spite of significant overlap. IBM is dragging the Dow while APPL carries the S&P...a great example of the shortcomings of each. Apple is about 7x the weight in S&P, while they're equal in the Dow.

There's also equal weight averages. Guggenheim (I think) has a set of sector ETFs that effectively work as sector indexes. And they have a S&P equal weight, that is fun to watch the disconnect with the index.

And, I think some use square root of market cap to lessen the impact, but still weight bigger companies more.

All the methods have advantages and shortcomings, depends on what you need. It's probably good to know though. Start with one index, then get lost for a while following links on Wikipedia.
 
Don't quote this but most indexes are weighted by market capitalization. For instance apple is 15% of the Nasdaq 100.

The index itself tracks the underlying, when you get into etf's and futures the markets will price in future dividends as well.
 
You can't buy an index... it's more like a price guide of a basket of stocks. Exchanges or media came up with that to give a measure of what the broad market is doing... It's easier to say "the Dow Jones Industrial went up today 1.2%" instead of " this tock went up this much and that stock dropped x etcetc."

So in effect, it's not tradable itself...

You can buy the underlying stocks, which make up the index, acdording to their individual weightings... thereby mimicking the index. Or something else that already copies it, like an ETF or derivative. If you would buy an ETF, the issuer of the ETF usually buys the underlyings to hedge their exposure...
 
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