Lesson 1 of 7 · 13 min

What an index is: value, price return and total return

An index is a paper portfolio that stands for a market; its price return version tracks only price changes, while its total return version also reinvests every dividend and coupon, so it pulls further ahead over time.

In short

  • A security market index represents a security market, a market segment or an asset class. Most are built as portfolios of marketable securities, the constituent securities.
  • Index value = sum of (units held × price) ÷ a divisor. The divisor sets a convenient starting value and is adjusted so that events unrelated to price moves do not change the index.
  • A price return index reflects prices only; a total return index also reflects the reinvestment of all income since inception.
  • Single-period index return = change in index value (plus income, for total return) ÷ beginning value, or equivalently the weighted average of the constituents' returns.
  • Over many periods, returns are linked geometrically: VT=V0(1+R1)(1+R2)⋯(1+RT)V_T = V_0(1 + R_1)(1 + R_2)\cdots(1 + R_T).
  • Both versions start at the same value; the total return version then exceeds the price return version by a growing amount.

Unlock this lesson free for 7 days

Create a free account to get 7 days of full access — every lesson, video, flashcard, mock and the question bank. No card needed.

Start your 7-day free trialLog in
What an index is: value, price return and total return · Security Market Indexes