PROBLEMS
5.4 B OND -M ARKET I NDEXES 6
in U.K. pound sterling, Japanese yen, euros, and the local currency of the country. In addition to the individual countries and the world index, there are several geographic subgroups, subgroups by market value, and by industry sectors. These indexes are available daily in the Financial Times.
Morgan Stanley Capital International (MSCI) IndexesThe Morgan Stanley Capital In- ternational Indexes consist of three international, 22 national, and 38 international industry indexes. The indexes consider some 1,673 companies listed on stock exchanges in 22 countries, with a combined market capitalization that represents approximately 60 percent of the aggre- gate market value of the stock exchanges of these countries. All the indexes are market value weighted.
The following relative valuation information is available: (1) price-to-book value (P/BV) ra- tio, (2) price-to-cash earnings (earnings plus depreciation) (P/CE) ratio, (3) price-to-earnings (P/E) ratio, and (4) dividend yield (YLD). These ratios help in analyzing different valuation levels among countries and over time for specific countries.
Notably, the Morgan Stanley group index for Europe, Australia, and the Far East (EAFE) is the basis for futures and options contracts on the Chicago Mercantile Exchange and the Chi- cago Board Options Exchange.
Dow Jones Wilshire Global Indexes The Dow Jones Wilshire Global Indexes is composed of more than 2,200 companies worldwide and organized into 120 industry groups. The index includes 35 countries representing more than 80 percent of the combined capitalization of these countries. In addition to the 35 individual countries shown in Exhibit 5.9, the countries are grouped into three major regions: Americas, Europe, and Pacific Region and some subre- gions. Finally, each country’s index is calculated in its own currency as well as in U.S. dollars.
The index for the individual countries is reported daily inThe Wall Street Journaland the full presentations as shown in Exhibit 5.9 is published weekly inBarron’s.
Comparison of World Stock Indexes As shown in Exhibit 5.10, the correlations between the three series since December 31, 1991, when the DJ series became available, indicate that the results with the various world stock indexes are quite comparable.
A summary of the characteristics of the major price-weighted, market-value-weighted, and equal-weighted stock price indexes for the United States and major foreign countries is con- tained in Exhibit 5A.1 in the chapter appendix. As shown, the major differences are the num- ber of stocks in alternative indexes, but more important is thesourceof the sample (e.g., stocks from the NYSE, NASDAQ, all U.S. stocks, or stocks from a foreign country such as the United Kingdom or Japan).
Exhibit 5.9D o w J o n e s W i l s h i r e G l o b a l I n d e x e s
Region/Country
DJ Global Indexes, Local Curr. 04/22/11
Wkly
% Chg.
DJ Global Indexes, U.S. $
04/22/11
Wkly
% Chg.
DJ Global Indexes, U.S. $
on 12/31/10
Point Chg.
From 12/31/10
% Chg.
From 12/31/10
Americas 3637.71 1.44 3412.82 224.89 6.59
Brazil 101389499.44 0.64 25517.69 1.12 24874.17 643.52 2.59
Canada 4634.24 1.21 5629.94 2.36 5193.84 436.10 8.40
Chile 8845.81 1.44 7103.16 2.72 7391.23 −288.07 −3.90
Mexico 23222.24 −0.63 6142.92 0.29 6119.20 23.72 0.39
U.S. 14029.05 1.37 14029.05 1.37 13131.47 897.58 6.84
Latin America 10737.13 1.06 10657.36 79.77 0.75
Europe 3880.41 2.02 2779.57 300.84 10.82
Austria 2912.70 0.58 3305.62 1.64 3065.28 240.34 7.84
Belgium 3344.44 0.74 3797.56 1.81 3382.71 414.85 12.26
Denmark 4781.12 0.83 5527.62 1.90 5006.27 521.35 10.41
Finland 10310.22 0.69 10465.11 1.75 10019.09 446.02 4.45
France 2742.94 1.16 3155.20 2.23 2754.84 400.36 14.53
Germany 2691.52 1.20 3045.00 2.27 2694.66 350.34 13.00
Greece 1207.12 −3.51 905.73 −2.49 847.41 58.32 6.68
Ireland 2063.17 0.15 2662.17 1.21 2394.79 267.38 11.17
Italy 2079.36 −0.30 1938.87 0.75 1661.89 276.98 16.67
Netherlands 2826.98 −0.51 3199.97 0.54 2884.78 315.19 10.93
Norway 4143.13 0.93 4626.71 1.61 4223.66 403.05 9.54
Portugal 1954.60 −1.10 1925.88 −0.06 1755.74 170.12 9.69
Russia 1482.20 1.20 1523.84 1.89 1315.47 208.37 15.84
Spain 4047.02 0.11 3452.23 1.17 2962.62 489.61 16.53
Sweden 6679.74 1.88 6085.33 3.76 5540.17 545.16 9.84
Switzerland 4154.96 1.18 6330.27 2.67 5941.48 388.79 6.54
United Kingdom 2563.12 0.49 2271.78 2.13 2097.91 173.87 8.29
South Africa 10104.13 1.33 4125.98 3.42 4228.78 −102.80 −2.43
Pacific Region 1419.18 2.10 1410.62 8.56 0.61
Australia 3134.45 1.23 4430.91 3.10 4083.61 347.30 8.50
China 2666.90 0.95 2662.40 1.05 2453.99 208.41 8.49
Hong Kong 4913.14 0.81 4919.85 0.91 4707.73 212.12 4.51
India 2021.13 0.79 2049.82 0.68 2146.38 −96.56 −4.50
Japan 522.72 0.21 798.06 2.01 856.66 −58.60 −6.84
Malaysia 2924.94 0.41 2645.95 0.91 2536.46 109.49 4.32
New Zealand 1326.44 1.17 1962.92 1.58 1840.28 122.64 6.66
Philippines 4346.43 0.48 2608.77 0.43 2350.55 78.22 3.09
Singapore 2148.15 0.97 2820.83 1.79 2726.96 93.87 3.44
South Korea 4144.49 2.46 2908.72 3.36 2592.91 315.81 12.18
Taiwan 2154.31 2.80 1922.46 3.31 1912.83 9.63 0.50
Thailand 2086.57 2.00 1646.70 2.87 1523.81 122.89 8.06
Euro Zone 3033.17 1.71 2674.00 359.17 13.43
Europe Developed (ex. U.K.) 3515.63 2.03 3147.59 368.04 11.69
Europe (Nordic) 5494.83 2.71 5046.88 447.95 8.88
Pacific (ex. Japan) 3807.29 2.15 3612.32 194.97 5.40
World (ex. U.S.) 2355.64 2.03 2232.41 123.23 5.52
DOW JONES GLOBAL TOTAL STOCK MARKET
INDEX 2767.19 1.75 2608.80 158.39 6.07
GLOBALDOW 2207.21 1.36 2087.44 119.77 5.74
Indexes based on 12/31/91 = 1000. © 2011 Dow Jones & Co., Inc. All Rights Reserved.
Source:Reprinted with permission ofBarron’sApril 25, 2011, p. M34. Copyright 2011 by Dow Jones & Co., Inc. All Rights Reserved Worldwide.
134 Part 1:The Investment Background
Notably, it is more difficult to create and compute a bond-market index than a stock-market index for several reasons. First, the universe of bonds is much broader than that of stocks, ranging from U.S. Treasury securities to bonds in default. Second, the universe of bonds is changing constantly because of new issues, bond maturities, calls, and bond sinking funds. Third, the volatility of prices for individual bonds and bond portfolios changes because bond price volatility is affected by duration, which is likewise changing constantly because of changes in maturity, coupon, and market yield.7 Finally, significant problems can arise in correctly pricing the individual bond issues in an index (especially corporate and mortgage bonds) compared to the current and continuous transactions prices available for most stocks used in stock indexes.
Our subsequent discussion is divided into the following three subsections: (1) U.S.
investment-grade bond indexes, including Treasuries; (2) U.S. high-yield bond indexes; and (3) global government bond indexes. All of these indexes indicate total rates of return for the portfolio of bonds and are market value weighted. Exhibit 5.11 contains a summary of the characteristics for the indexes available for these three segments of the bond market.
5.4.1 U.S. Investment-Grade Bond Indexes
As shown in Exhibit 5.11, four investment firms have created and maintain indexes for Trea- sury bonds and other bonds considered investment grade, that is, the bonds are rated BBB (or Baa) or higher. As demonstrated in a subsequent section, the relationship among the returns for these investment-grade bonds is strong (that is, correlations average about 0.95), regardless of the segment of the market.
5.4.2 High-Yield Bond Indexes
One of the fastest-growing segments of the U.S. bond market during the past 30 years has been the high-yield bond market, which includes bonds that are not investment grade—
that is, they are rated Ba, B, Caa, Ca, and C. Because of this growth, four investment firms created indexes related to this market. A summary of the characteristics for these indexes is included in Exhibit 5.11. For an analysis of the alternative high-yield bond benchmarks, see Reilly and Wright (1994); for an overall analysis of this market, see Reilly, Wright, and Gentry (2009).
5.4.3 Global Government Bond Indexes
The global bond market has experienced significant growth in size and importance during the past 15 years. Notably, this global bond segment is dominated by government (sovereign) bonds because most non-U.S. countries do not have a viable corporate bond market. Once again, several major investment firms have created indexes that reflect the performance for the global bond market. As shown in Exhibit 5.11, although the various indexes have similar
Exhibit 5.10C o r r e l a t i o n s o f P e r c e n t a g e P r i c e C h a n g e s o f A l t e r n a t i v e W o r l d S t o c k I n d e x e s 1 2 / 3 1 / 9 1–1 2 / 3 1 / 1 0
U.S. Dollars
Financial Times/S&P-MSCI .996
Financial Times/S&P-Dow Jones .995
MSCI-Dow Jones .993
7This concept is discussed in detail in Chapter 18.
Exhibit 5.11S u m m a r y o f B o n d - M a r k e t I n d e x e s
Name of Index
Number of
Issues Maturity Size of Issues Weighting Pricing
Reinvestment
Assumption Subindexes Available Barclay Capital 8,000 Over 1 Year Over $250 million Market value Trader priced
and model priced
No Government, gov./corp., corporate mortgage- backed, asset-backed Merrill Lynch/Bank of
America
6,000 Over 1 Year Over $50 million Market value Trader priced and model priced
In specific bonds
Government, gov./corp., corporate, mortgage Ryan Treasury 300+ Over 1 Year All Treasury Market value
and equal
Trader priced In specific bonds
Treasury Morgan Stanley/Smith
Barney
5,000+ Over 1 Year Over $50 million Market value Trader priced In one-month T-bill
Treas.-agency, broad inv.
grade, corporate, mortgage U.S. High-Yield Bond
Indexes
C. S. First Boston 500+ All Maturities Over $75 million Market value Trader priced Yes Composite and by rating Barclay Capital 1,800 Over 1 Year Over $100 million Market value Trader priced No Composite and by rating Merrill Lynch/Bank of
America
2,000 Over 1 Year Over $25 million Market value Trader priced Yes Composite and by rating Morgan Stanley/Smith
Barney
300+ Over 7 Years Over $50 million Market value Trader priced Yes Composite and by rating Global Government
Bond Indexes
Barclay Capital 1,200 Over 1 Year Over $200 million Market value Trader Priced Yes Composite and 13 countries, local and U.S. dollars Merrill Lynch/Bank of
America
800 Over 1 Year Over $50 million Market value Trader Priced Yes Composite and 9 countries, local and U.S. dollars J. P. Morgan 700 Over 1 Year Over $100 million Market value Trader priced Yes in Index Composite and 11 countries,
local and U.S. dollars Morgan Stanley/Smith
Barney
525 Over 1 Year Over $250 million Market value Trader priced Yes at local Short-term
rate
Composite and 14 countries, local and U.S. dollars
Source:Updated from Frank K. Reilly, Wenchi Kao, and David J. Wright,“Alternative Bond Market Indexes,”Financial Analysts Journal 48, no. 3 (May–June, 1992):
14–58; Frank K. Reilly and David J. Wright,“An Analysis of High-Yield Bond Bench marks,”Journal of Fixed Income 3, no. 4 (March 1994): 6–24; and Frank K. Reilly and David J. Wright,“Global Bond Markets: Alternative Benchmarks and Risk-Return Performance,”presented at Midwest Finance Association Meeting, Chicago, IL, March 2000.
136Part1:TheInvestmentBackground
computational characteristics, the total sample sizes and the numbers of countries included differ. Exhibit 5.12 is a table available daily in The Wall Street Journal that contains current results for a variety of domestic and global bond indexes.