7. Stock Market Indices

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Introduction Stock market indices are the barometers of the stock

market. They mirror the stock market behavior. Withsome 7000 companies listed on BSE, it is not possibleto look at the prices of every stock to find out whetherthe 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


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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 arereflected on stock market.

The investor can use the indices to allocate fundsrationally among stocks. To earn returns on par withthe market returns, he can choose the stocks thatreflect the market movement.


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Technical analysis studying the historical performanceof the indices predict the future movement of thestock market. Te relationship between the individualstock and index predicts the individual share pricemovement.


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Computation of stock indexA stock market index may either be a price index or a

wealth index. The unweighted price index is a simplearithmetic average of share prices with a base date. Theindex gives an idea about the general price movementof the constituents that reflects the entire market. Thefollowing example gives the calculation procedure forthe wealth index.


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Let us take an example of an index constructed withthree 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


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Market capitalization (MC) = No. of shares x price ofshares

X= 100 x 20 = 2000Y= 200 x 30 = 6000

Z= 250 x 40 = 10000

Aggregate market capitalisation = 18000

Index at period N=100


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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


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Index at N + 1 period = 23000 x 100/18000 = 127.78

The calculation of index in India is based on free float

methodology.


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Difference between the indices The indices are different from each other to a certain

extent. Some times the Sensex may move up by 100points but NSE nifty may move only 40 points. Themain factors that differentiate one index from otherare given below.

(I) No. of component stock

(II) The composition of stocks(III)The weights

(IV)Base year


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The BSE SENSITIVE index The BSE SENSITIVE index has been long known as

the barometer of the daily temperature of Indianbourses. In 1978-79 stock market contained only

private sector companies and they were mostlygeared to commodity production. Hence a sample 30was drawn from them. With the passage of timemore and more companies private as well as publiccame into the market. Even though the no. of scripsin the Sensex basket remained the same 30,representatives were given to new industrial sectorssuch as services telecom, auto sector etc.


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The continuity and integrity of index are kept intact,so that a comparison of the current market conditionswith those of decade ago is made easy and anydistortion in the market analysis is avoided. Thequantitative and qualitative criteria adopted in theselection of 30 scrips are listed.

(I) Industry representation

(II) Track record


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Quantitative criteria

(III) Market capitalisation

(IV) Liquidity


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Industry representation: the companys scrip shouldreflect the present state of the industry and its futureprospects. Companies should be representative ofindustry

Track record: the company should have acceptabletrack record of good performance in terms ofcorporate governance and dividend payment. Thecompany should have listing history of at least oneyear on BSE.


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Market capitalisation: the scrip should be amongtop 100 companies listed by full market capitalisation.The weight of each Sensex scrip based on free floatshould be at least 0.5% of the index. Marketcapitalisation should be average for last six months.

Liquidity: the liquidity is based on trading frequency,average daily trades and average daily turnover. Thescrip should have been traded on each and everytrading day for the last one year except for the extremereasons like scrip suspension.

7. Stock Market Indices

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