Price Indices

BY – Kakul Trivedi

What Is Price IndexA price index (plural: “price indices” or

“price indexes”) is a normalized average (typically a weighted average) of prices for a given class of goods or services in a given region, during a given interval of time. It is a statistic designed to help to compare how these prices, taken as a whole, differ between time periods or geographical locations.

UTILITY Price indices have several potential uses. For

particularly broad indices, the index can be said to measure the economy's price level or a cost of living. More narrow price indices can help producers with business plans and pricing. Sometimes, they can be useful in helping to guide investment.

Types of IndicesConsumer Price Index(CPI)Wholesale Price index(WPI)/ Producer Price

IndexSENSEXNIFTY

CONSUMER PRICE INDEX

“A measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services."

Calculating CPI:

For single item: CPI1/CPI2 = Price1 / Price2

For multiple items: CPI = (CPI1 +..+ CPIn ) * WEIGHT

Wholesale Price Index It measures average changes in prices

received by domestic producers for their output.

The Wholesale Price Index (WPI) is the index used to measure the changes in the average price level of goods traded in wholesale market.

A total of 435 commodity prices make up the index. It is available on a weekly basis, with the shortest possible measurement lag being two weeks.

Because of this, it is widely used in business and industry circles and in Government, and is generally taken as an indicator of the inflation rate in the economy.

Calculating WPIThe formula used to calculate the PPIs is a

modified Laspeyre’s index. The Laspeyre’s index compares the base period revenue for a set of goods to the current period revenue for the same set of goods.

SENSEXAn abbreviation of the Bombay Exchange

Sensitive Index (Sensex) - the benchmark index of the Bombay Stock Exchange (BSE). It is composed of 30 of the largest and most actively-traded stocks on the BSE. Initially compiled in 1986, the Sensex is the oldest stock index in India.

Calculation of SENSEXToday's Market Cap/ Yesterdays Market Cap

= Something and this something* yesterdays SENSEX, you will get today's SENSEX.

OR, Free Float Capitalization * Index Divisor =

INDEX

Market Capitalization:It is the measure of total market value of a

companies all of the outstanding shares.Market Capitalization is popularly known as

MCAP.

Calculating Market Capitalization

MCAP = Total Outstanding shares * Share Value

FREE FLOAT FACTORFree Floating shares are the ones which are

readily traded in the market excluding restricted stocks.

The ratio or the percentage of floated shares to the outstanding shares is the Free Float Factor for a stock.

FREE FLOAT CAPITALIZATIONWhen weighting the effect of the company on

the index we need to find it’s Free Floating Capitalization

Market Capitalization multiplied by the Free Float Factor gives the Free Floating Capitalization.

An Example will clarify the doubts

Suppose the Index consists of only 2 stocks: Stock A and Stock B. Suppose company A has 1,000 shares in total, of which 200 are held by the promoters, so that only 800 shares are available for trading to the general public. These 800 shares are the so-called 'free-floating' shares. Similarly, company B has 2,000 shares in total, of which 1,000 are held by the promoters and the rest 1,000 are free-floating. Now suppose the current market price of stock A is Rs 120. Thus, the 'total' market capitalization of company A is Rs 120,000 (1,000 x 120), but its free-float market capitalization is Rs 96,000 (800 x 120). Similarly, suppose the current market price of stock B is Rs 200. The total market capitalization of company B will thus be Rs 400,000 (2,000 x 200), but its free-float market cap is only Rs 200,000 (1,000 x 200).

So as of today the market capitalization of the index (i.e. stocks A and B) is Rs 520,000 (Rs 120,000 + Rs 400,000); while the free-float market capitalization of the index is Rs 296,000. (Rs 96,000 + Rs 200,000). The year 1978-79 is considered the base year of the index with a value set to 100. What this means is that suppose at that time the market capitalization of the stocks that comprised the index then was, say, 60,000 (remember at that time there may have been some other stocks in the index, not A and B, but that does not matter), then we assume that an index market cap of 60,000 is equal to an index-value of 100. Thus the value of the index today is = 296,000 x 100/60,000 = 493.33 This is how the SENSEX is calculated. The factor 100/60000 is called index divisor.

NIFTY

Nifty A select group of fifty shares of the National Stock Exchange or NSE of India. These constitute the NSE – FIFTY index.

 

50 blue-chip stocks that were regarded as profitable long-term investments during the 1960s and 1970s. The practice of buying and holding the nifty 50 is considered to be largely responsible for the bull market of the early 1970s; indeed the prices for the nifty 50 were driven up to very high, unsustainable levels. Most of the nifty 50 had strong growth rates and low P/E ratios. Examples included Anheuser-Busch and American Express. They were also called the Favorite 50.

Market Capitalization

Companies eligible for inclusion in Nifty must have a six monthly average market capitalization of Rs.500 crores or more during the last six months.

Floating Stock

Companies eligible for inclusion in S&P CNX Nifty should have at least 10% floating stock. For this purpose, floating stock shall mean stocks which are not held by the promoters and associated entities (where identifiable) of such companies.

Others

A company which comes out with a IPO will be eligible for inclusion in the index, if it fulfills the normal eligibility criteria for the index like impact cost, market capitalization and floating stock, for a 3 month period instead of a 6 month period.

BIBLIOGRAPHYwww.BSEindia.comwww.wikipedia.orgwww.investopedia.comwww.coolavenues.comwww.answers.comwww.querycat.comwww.investorwords.comwww.financial-

dictionary.thefreedictionary.com

THANK YOU