46.c: Index Construction
Index construction
Key steps in building an index:
- Identification of target market
- Selection of securities from the target markets
- Assigning weights to the selected securities
- Rebalancing the index
- Re-examining the constituents and their weights
Target markets can be identified on the basis of geography (US, Europe, global), asset class (equities, bonds, commodities), exchange (S&P500, Nikkei), sector (banking, infrastructure) etc. Once the target market has been identified, the next step is to decide the number of securities you want in the index. It can be the total number of securities available in the target market or just a sample of securities, which can best reflect the pricing trend of the sector. The decision can be driven by some objective rule (for e.g. top 50 largest stocks by market capitalization) or subjective decision of a committee.
