Most popular share market indexes

In this article we will discuss about most popular share market indexes such as Dow Jones Industrial Average (DJIA), S & P 500 and NASDAQ. Our discussion will include overall analysis of this popular market indexes and their effect on financial market.

Dow Jones Industrial Average (DJIA)

DJIA is the second oldest stock market index after Dow Jones Transportation Average. This index is found in way back 1885. The index consists of average of the price of 30 large public companies in United States. The value of the Dow is not the actual average of the prices of its component stocks, rather the sum of the component prices divided by a divisor (D), which changes whenever one of the component stocks has a stock split or stock dividend, so as to generate a consistent value for the index. So, the formula for calculating DJIA is-

Where, p is the prices of the component stocks and d is the Dow Divisor.

What kinds of stocks are traded over the DJIA?

DJIA consists of stocks from various types of industries. Actually, DJIA covers all major areas of US economy except transportation sector and utility sector. This is because for this sector there are dedicated index available. It consists of 30 most familiar blue chip companies of United States.

S & P 500

This is a stock market index based o market capitalization of 500 large companies having common stock listed in New York Stock Exchange. It differs from other U.S. stock market indices such as DJIA and NASDAQ due to its diverse constituency and weighting methodology. It is one of the most commonly followed equity indices and many investors consider it the best representation of the U.S. stock market.

The formula to calculate the S&P 500 Index value is:

Where, P is the price of each stock in the index and Q is the number of shares publicly available for each stock.

What kinds of stocks are traded over the S&P 500?

The S&P 500 covers almost all major areas of the U.S. economy. It does not take 500 largest companies; rather it takes 500 most widely held companies - chosen with respect to market size, liquidity and industrial sector.  These components are chosen by the S&P Index Committee. Anywhere from 25-50 changes are made every year because of the change in status of the company due to mergers or fallouts. International companies have been included in the past, but only U.S. companies will be added in the future.

NASDAQ

NASDAQ is the second largest stock market after NYSE. NASDAQ has two popular indexes named NASDAQ-100 and NASDAQ Bank Index. As named suggests NASDAQ-100 consists of the 100 most wider stocks listed in NASDAQ. This is a weighted price index.

What kinds of stocks are traded over the NASDAQ?

The National Association of Securities Dealers Automated Quotation system, or NASDAQ, was established in 1971 as a way to increase trading for over-the-counter stocks. These are stocks that are not able to meet the requirements to be listed on larger exchanges such as NYSE. So, it is quite clear that NASDAQ consists of small and medium type of stocks.

In order to answer question of an investor as why one index go up and other does not or fall out we will say this is simply because components of that index. If stock price of the 30 companies in DJIA does not move significantly then DJIA will not change much but at the same time if stocks of S & P 500 could be change. Another reason for this could be the way of calculation of that particular index.

How are these three financial markets related?

As we discussed above, this indexes indicates market capitalization of the companies consists of this indexes. So, it reflects market overall scenario for this stocks and market at large. It is a tool widely used by investors and financial analyzers to describe the market, and to compare the return on specific investments.

CAPITAL PLAN AUDIT

This articl is made to discuss about audit of capital plan and review of status of company’s compliance with the provision of Sarbanes Oxley Act of 2002. This act requires that a review about material weaknesses in internal controls. This discussion will include- 

  Objectives of capital plan audit -

There are various objectives significant to the audit of capital planning process. Main objectives of audit of capital planning are-

Review every capital decision and judge whether those are consistent with the enterprise capital, financial and operating architecture -

One of the key objectives of capital planning audit is to review every capital expenditure and decision taken in context of the company’s capital structure. Further, it is to be judge whether appropriate consideration has been made in respect of financial and operational factors before making such decisions.

Review of Cost and benefit analysis of each capital decision -

Auditor of a capital planning team shall judge whether each capital decision has adequate backing of cost and benefit analysis. This analysis will provide a overall idea whether this capital project will run well or not.

Review of internal control used for capital decisions-

Key aspect of a Capital planning audit is to verify whether proper internal control in respect of these decisions is in place. Internal control system consists of managers, supervisors and board forms an integral part of a capital planning decision. Proper structure of a capital planning team is considered to be most important for executing a capital planning decision.

 Review of implementation procedure adopted for a capital plan-   

Capital planning is a long term procedure and in order gets sustainable success in capital planning throughout monitoring in implementation of capital plan shall be done. Auditor’s job is to identify the implementation procedure adopted by the company and judge whether that is sufficient to achieve objective of the plan.

Ensure all legal compliance-

One of very key aspect of capital plan audit is to ensure whether decision has been taken in view of all necessary compliance such as Sarbanes Oxley Act or any other act applicable for this purpose. Because a proper capital plan without compliance will surely be a failure in long run.

Apart from the objectives stated above there are some key objective of capital plan are stated below-

•To justify capital funding requirement

• To done proper risk assessment

ü  Identify and sufficiently test controls that are intended to address the risks of material misstatement;

ü  Obtain sufficient evidence to update the results of testing of controls from an interim date to the company's year.

ü  Sufficiently test controls over the system generated data and reports that support important controls.

• To ensure accountability in capital planning

• To judge reliability of target resources and plan expenditures

• To review of long range capital plans

·         Internal control Audit Report and reportable issues under SOX –

We have audited financial system and internal control of xxx company. This audit report shall include a judgment about internal control of xxx company. We conducted our audit in accordance with auditing standards generally accepted in the United States of America and the standards applicable to financial audits contained in Government Auditing Standards issued by the Comptroller General of the United States.

Deficiency in internal control can be observed as data used for calculating growth and coat of capital is consistent enough. This observation simply exposed non-existence of structural internal control of the organization.

 This report includes recommendations regarding reportable issues under Sarbanes Oxley Act. The Sarbanes Oxley Act, 2002 requires company’s management to assess and report in respect of effectiveness of internal control of the entity. Section 404 of this act requires auditor to report on adequacy on internal control of the entity. Reportable issues under this act are-

1. Whether a proper internal control on financial reporting and operation is exists in the organization

2.  Report in respect of results of test of control procedures.

Recommended improvement in internal control to control weakness in capital plan -

Internal control forms an integral part of the entity and it is observed that UPC’s internal control has some weaknesses which provide inconsistent data for analysis. In order to address this issue following steps can be taken-

• Internal control shall be documented and integrated through formal and informal channels into the elements of management system.

• Documentations are only the beginning of risk management. Rather it shall be ensured that proper understanding of the system has been done by the people involved in this system.

•  Assign particular responsibilities to every person of the internal control team and make them accountable for every decision.

• Determine how change in internal control approved, implemented and monitored.

• Organizations need a structured process to ensure that the internal control system is being thoroughly evaluated on a timely basis.

• Define a corrective action plan for major control weaknesses.

·         Qualitative factors involved in decision making-

There are some key qualitative factors to a decision making process. Ignoring this factors could create a risk of failure of project. Those factors are-

• SWOT Analysis

• Human Resource Management

• Public Image

• Long term survival

• Stakeholders’ analysis of projects

Other Factors-

• Political

• Economic

• Social

• Technological

There is huge amount of risks associates with these factors so, ignoring it could lead to a bigger problem. These risks could be-

•   Internal decision of company conflicts with political principles.

•   Negative reaction of local community to the project. 

•   Government policy does not support project.

•   De-motivated human resource of the company

• Social impact of the project is not indefinable or negative.

This all are qualitative factors, hence very subjective and cannot be taken lightly.

Capital Planning, its risks and techniques

• Challenges associated with the capital planning process-

Capital planning includes business strategy risk as well as management and corporate governance. It is both science and arts at the same time. Simply put it is not mere mathematical exercise. The process of capital planning must looks into the future and to stresses that it did not previously contemplated both on the business and on capital. Major elements involved in capital planning are risk, capital and governance.

Risk – Identify the assets material risk and measure the risk that is reliably identifiable.

Capital – Set internal capital adequacy goals that relate direct to risk. This should me made based on risk tolerance level of the entity. Assessment shall be made whether risk is easily measurable or not.

Governance – It is important to develop and maintain a framework which support different aspects of capital planning. 

Major challenges associated with this process are-

ü  Data challenges- Capital planning includes huge analysis of data’s from financial market and from the inside source of the company. Hence, it is very important that every data used in a capital planning process is accurate for providing significant result. However, there are so many data is used in this process, which is mere assumption, and challenges lies over there.

ü  Governance challenges – Most of the time capital planning is undergone under supervision of board. Key governance issues involved over here is managing the whole procedures going through various phases.

                                                                                                                

ü  MIS challenges- As it is discussed earlier that this process requires huge amount data hence a sound management information system is of the prime importance for a capital planning process.

ü  Modeling challenges – The model are based mainly of two functions explicit functions and implicit functions.

ü  Assumptions and limitations- As it is stated earlier the process of capital planning involved lots of assumptions and that is the reasons, which create limitations of this procedures.

Risks involved in capital planning-

Capital planning involves risk management decision making at the firm wide unit and line level. Capital planning is aligned with overall risk management process and business risk measures. Budgeting for capital assets is a tricky business that involves uncertain projections (and therefore a high degree of risk), dependence on a range of expertise, linking long-term projections with financial plans, and stringent record keeping and reporting. Various type of risks involved in capital planning are-

o   Volatility risks

o   Investment risks

o   Market risks

o   Corporate risk

o   International risk

o   Stand-alone risk

o   Competitive risk 

o   Project specific risk

o   Industry specific risk

Techniques for minimizing the risks- 

The process of minimizing risks starts with identification of risks. It will also involve a comparison and analysis in respect of risk tolerances across the organization. After these steps, measurement of risks is carried out to judge materiality effect of risks. Financial and business risk has two different type of risk reducing techniques. Following are key risk assessment and reducing techniques used in capital planning-

o   Sensitivity Analysis- This is “what if analysis” because of uncertainty of future.

o   Scenario Analysis- Focus over here lies on deviation of number of in corrected variables. 

o   Break Even Analysis- Provides a basis of judging minimum capital required and risk can be tolerated.

o   Hillier Model- analytical process of judging risks

o   Simulation Analysis- Judge Risks based on random variables.

o   Decision Tree Analysis - Assessment of alternative.

o   Corporate Risk Analysis – Analyze risks entire cash flow of firm.

                                                      

o   Risk Management – Focus on various strategies.

o   Selection of project under risk – Judgmental procedure

o   Practical Risk Analysis- It’s a border concept, involves lots of analysis of implicit and explicit data.