Bond Market Indexes

Although almost all of the major stock market indexes exclude dividends and thus are not total return indexes, the major bond indexes are total return indexes, for they include interest payments as well as capital gains.14 The best known bond indexes are constructed by Lehman Brothers, Merrill Lynch, and Salomon Brothers. They are all market-weighted total return indexes including all issues above a certain size. Furthermore, subindexes exist covering different parts of the bond market by maturity as well as by type of issuer.

Perhaps the use of market weighting and the inclusion of cash flows (interest) in the indexes reflects the fact that bond indexes were constructed more recently than stock indexes, when the concepts of market weighting and total return were better understood.

12The stock split could affect expectations about the future cash flows of the firm and its market value.

13The monthly version of the CRSP index treats all dividends paid on a stock as reinvested at the end of the month. The assumption is implicitly made that cash payments earn no return during the remainder of the month in which they are paid.

14Lehman Brothers and Salomon Brothers compute their indexes on a monthly basis and assume any interest paid during a month is reinvested at the end of the month. Merrill Lynch computes their indexes on a daily basis and reinvests paid interest at the end of the day. All prices used in computing these indexes are quoted price plus accrued interest. This is the price an investor would have to pay for the bond.

One caution on using these indexes is that a number of issues in the indexes are not actively traded. The prices of these issues represent price estimates based on issues that are traded; this estimation process can be a source of inaccuracy.

The set of bond indexes with the longest history are those compiled by Ibbotson and Associates. Ibbotson reports monthly returns from the beginning of 1926 to the present for Treasury bills, long-term government bonds, intermediate-term government bonds, and long-term corporate bonds. These series are excellent for gaining perspective on the major bond markets because of their long history. However, the user of these series should be aware that the number of bonds included in each of the series are not the same. For example (a) the long-term corporate bond series currently includes nearly all Aaa and Aa rated corporate bonds, whereas (b) the long-term government bond series is based on a single government bond of approximately 20 years maturity selected at the start of each year.15

The indexes mentioned earlier compiled by Merrill Lynch, Salomon, and Lehman both cover more bonds and include indexes for more sectors than the Ibbotson indexes; however, they are only available for a much shorter period of time.

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