Introduction • Stock market indices are the barometers of the stock market. They mirror the stock market behavior. With some 7000 companies listed on BSE, it is not possible to look at the prices of every stock to find out whether the market movement is upward or downward. • The indices give a broad outline of the market movement and represent the market. • Some of the stock market indices are: Sensex, NIFTY, BSE-200, CRISIL-500
Usefulness of indices • Indices help to recognise the broad trends in the market. • Index can be used as a bench mark for evaluating the investors portfolio. • Indices function as a status report on the general economy. Impact of various economic policies are reflected on stock market. • The investor can use the indices to allocate funds rationally among stocks. To earn returns on par with the market returns, he can choose the stocks that reflect the market movement.
Technical analysis studying the historical performance of the indices predict the future movement of the stock market. Te relationship between the individual stock and index predicts the individual share price movement.
Computation of stock index • A stock market index may either be a price index or a wealth index. The unweighted price index is a simple arithmetic average of share prices with a base date. The index gives an idea about the general price movement of the constituents that reflects the entire market. The following example gives the calculation procedure for the wealth index.
Let us take an example of an index constructed with three scrips X Y Z. • Equity of company X: 100 (par value Rs 10) • Equity of company Y: 200 (par value Rs 10) • Equity of company Z: 250 (par value Rs 10) • Market price of scrip X: Rs 20 • Market price of scrip Y: Rs 30 • Market price of scrip Z: Rs 40
Market capitalization (MC) = No. of shares x price of shares • X= 100 x 20 = 2000 • Y= 200 x 30 = 6000 • Z= 250 x 40 = 10000 • Aggregate market capitalisation = 18000 • Index at period N=100
Market price at N + 1 period • Market price of scrip X: Rs 25 • Market price of scrip Y: Rs 40 • Market price of scrip Z: Rs 50 • Market capitalisation: • X= 100 x 25 = 2500 • Y= 200 x 40 = 8000 • Z= 250 x 50 = 12500 • Aggregate market capitalisation = 23000
Index at N + 1 period = 23000 x 100/18000 = 127.78 • The calculation of index in India is based on free float methodology.
Difference between the indices • The indices are different from each other to a certain extent. Some times the Sensex may move up by 100 points but NSE nifty may move only 40 points. The main factors that differentiate one index from other are given below. • No. of component stock • The composition of stocks • The weights • Base year
The BSE SENSITIVE index • The BSE SENSITIVE index has been long known as the barometer of the daily temperature of Indian bourses. In 1978-79 stock market contained only private sector companies and they were mostly geared to commodity production. Hence a sample 30 was drawn from them. With the passage of time more and more companies private as well as public came into the market. Even though the no. of scrips in the Sensex basket remained the same 30, representatives were given to new industrial sectors such as services telecom, auto sector etc.
The continuity and integrity of index are kept intact, so that a comparison of the current market conditions with those of decade ago is made easy and any distortion in the market analysis is avoided. The quantitative and qualitative criteria adopted in the selection of 30 scrips are listed. • Industry representation • Track record
Quantitative criteria (III) Market capitalisation (IV) Liquidity
Industry representation: the company’s scrip should reflect the present state of the industry and its future prospects. Companies should be representative of industry • Track record: the company should have acceptable track record of good performance in terms of corporate governance and dividend payment. The company should have listing history of at least one year on BSE.
Market capitalisation: the scrip should be among top 100 companies listed by full market capitalisation. The weight of each Sensex scrip based on free float should be at least 0.5% of the index. Market capitalisation should be average for last six months. • Liquidity: the liquidity is based on trading frequency, average daily trades and average daily turnover. The scrip should have been traded on each and every trading day for the last one year except for the extreme reasons like scrip suspension.