ACST252 Finance and Financial Reporting

Topic 1 Overview: Context of the Economy and the Financial Markets,

The Corporation and Its Objectives

Market Case Study

Introduction

An important proxy of how markets are performing in general is the equity market index.
However, this proxy can be misleading as the index structure may distort the reading and
provide a false impression that everything is fine.

This exercise will require you to investigate a well-known market index, the Standard and
Poors 500 Index (S&P 500 Index) that tracks the performance of the largest 500 companies listed
on the New York Stock Exchange. You will learn about how indices may be structured, how the
structure can distort the market and also how the mainstream media may be reporting
incomplete information about the actual conditions of the market. Furthermore, you will
develop your MS Excel skills as well as provide you an opportunity to apply your statistical
data analysis skills from first year in a practical environment.

The Context of the Current Market

With over seven years of zero interest rate policy and dubious results, the previous Federal
Reserve President, Ben Bernanke, announced that they would begin to reduce currency printing
and seek to return the US economy (and the global economy for that matter) to normal. His
successor, Janet Yellen, inherited this policy at the start of 2014, ending effectively all currency
printing in October 2014. The next step was to start increasing interest rates from 0-0.25% to
more normal levels.

During 2015, the global economy experienced much volatility and this impacted on the US
economy. Janet Yellen used many excuses to delay interest rate rises and finally raised it at the
last meeting of the year. Within three weeks, the global economy started showing signs of
weakness and panic as asset prices fell and demand for physical goods (represented by
commodities) further exacerbated the pessimism.

The current state of the US economy is subject to much debate, with much data being released
that is used to paint contrasting pictures. Exactly what is the true state of the economy then is
it recovering because of reported increases in jobs and the strong recovery of the financial

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markets or is it a mirage as the real wage growth is stagnant and many jobs that are created are
not sufficient to sustain a family? Or is it both?

Answering this question is difficult and may border on impossible because of a myriad
measures that can be used to represent the economy and different factors may drive this. At
best, we can have a look at one of the many aspect of the economy that the media speaks widely
about.

We will look at the US stock market via the Standard and Poors 500 Index that represents the
largest 500 companies across the ten sectors. The data for the index and the constituents are
online under the file SP500 Index Data 160125.xlsx.

You may find these articles useful as a starting point:

http://www.zerohedge.com/news/2015-12-08/going-fang-less

http://www.zerohedge.com/news/2015-12-10/whole-lot-new-lows-market-near-its-high

In-Tutorial Activity

Create two new worksheets called PriceResults and ReturnsResults. In each worksheet,
copy the companies into the top row and then in the 2nd row, write down the starting date of
trading for each company stock (the first date for which there is numerical data for price and
returns). Set the beginning entry in the period at 100 for each company. Then calculate the
standardised returns of the stock based on the price and the returns index over the period. Do
this for both 1/1/2014 to 25/1/2016 (since the beginning of the Federal Reserve policy of
reversing their accommodative policy) and 1/1/2015 to 31/12/2015 (for the year of 2015 when
Janet Yellen intended to raise interest rates)

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Homework Activity

1. How is the S&P 500 Index structured? How does each company constituent contribute to
the index?
2. Your dataset contains price and returns index data. What is the difference between the
stock price and returns? (As an example, look at the rate of return generated over the
period for the stock 3M using the price measure and the returns index)
3. Referring to the dataset, answer the following questions:
a.) How did the S&P 500 Index perform over the two periods?
b.) How many companies delivered positive returns over the two periods? What is the
proportion?
c.) What distortions, if any, can you identify about this index as an indicator of the general
economy?
d.) What further tests or information can you suggest to improve your study? Consider the
statistical tests you have encountered in STAT171 and perform one or two.

Presentation Task (Due in the Week 5 Tutorial)

In a group of 3-5 people, prepare a presentation that discusses the S&P 500 Index and its
appropriateness for its reflection of the state of the general economy. You may want to perform
a quantitative analysis to demonstrate the level of distortion, or otherwise, of the index by the
index structure and the constituents. Also, discuss briefly what further information you may
need to assist your investigation.

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