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What is an index?
An index is a group of securities reflecting a securities market or a particular segment of a securities market. It is used to measure and report the fluctuations of the market or market corner it represents. As you might guess, stock indexes track the stock market, and bond indexes track the bond market. Largely because of the popularity of stocks over bonds as a vehicle for the average investor, stock indexes far outnumber bond indexes. There also are indexes for various other markets, such as commodities and currency.
Both types of indexes can help you with the process of building and running your investment portfolio. You can structure part of your portfolio to replicate a particular index, you can invest in mutual funds or exchange-traded funds that are based on a particular index, or you can simply use indexes to monitor various markets. The headings that follow provide more detailed information on various indexes, and how you might consider using them.
In addition to stock indexes, there are several different bond indexes. These indexes are aggregate measures that track the bond market or particular segments of it. The various bond indexes are compiled and published by bond-rating agencies, the Federal Reserve Board, brokerage firms, and financial publications. Like stock indexes, most of the bond indexes use a limited number of bond issues to chart the price movement of a larger universe of bonds. There are composite bond indexes that measure the price movement of a wide variety of bonds. There are also indexes that measure the price of municipal bonds, some that chart the price movement of utility bonds, and numerous others that cover the entire spectrum of available bonds.
Most bond indexes measure either the underlying price movement of the bonds in the index and/or the fluctuating yields of the bonds. Many bonds are issued in denominations of $1,000 with a set yield (i.e., the bond issuer will pay a set amount of interest each year until maturity). The price of the bond will then fluctuate in the marketplace as interest rates for similar bonds rise or fall. If interest rates fall after the issuance of a bond, the price of the bond will rise (so the yield on that bond will be comparable to other similar bonds in the marketplace).
Similarly, if interest rates rise, the price of the bond will fall. This is commonly referred to as the inverse relationship between interest rates and bond prices. How much the bond price will rise or fall depends on the length of the maturity, the bond rating, and other factors. Many of the bond indexes, therefore, track the actual underlying price movement of the bonds, although some will directly track bond yields. Other bond indexes compile and publish both the bond prices and the corresponding yields.
How can you use bond indexes?
Many investors use bond indexes to follow broad trends in the various bond markets. Institutional bond investors often use the indexes as a benchmark against which to measure their performance. For example, an institutional bond fund manager who invests in municipal bonds may use one of the municipal bond indexes to measure his or her performance. Similarly, an individual may use a bond index to compare and contrast performance on bond mutual funds.
In addition, some investors believe that bond indexes may be used as indicators of stock price trends. Historically, there tends to be an inverse relationship between bond yields and stock prices—when bond yields go down, stock prices go up. Stock investors therefore sometimes study bond indexes to try to discern trends in the price and yield movement of bonds.
Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2019.