PROJECT REPORT ON “COMPUTATION OF INDICES ( SENSEX AND NIFTY)” SUBMITTED RASHTRASANT TUKADOJI MAHARAJ NAGPUR UNIVERSITY, NAGPURIN PARTIAL FULFILLMENT OF THE REQUIREMENT FOR THE DEGREE OF BACHELOR OF BUSINESS ADMINISTRATION BY Ku. Swati V. Nikhare UNDER THE GUIDANCE OF Shri. Mahesh Joshi Department of Business Management, C. P. & Berar Education Society’s College, Ravinagar, Nagpur. 2009-2010 1
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This is to certify thatKu. Swati V. Nikhare is a bonafied student of Department of Business Management, C. P. & Berar E. S. College, Nagpur and studying in B.B.A. Finalyear and has completed his project titled
“COMPUTATION OF INDICES ( SENSEX AND NIFTY)”
This project report is submitted to RTM Nagpur University in partial fulfillment of
academic requirement for the degree of Bachelor of Business Administration during the
academic year 2009-2010.
I find the work comprehensive, complete and of sufficiently high standard to warrant its
A statistical measure of change in an economy or a securities market. In the case of financial
markets, an index is an imaginary portfolio of securities representing a particular market or a portion of it. Each index has its own calculation methodology and is usually expressed in
terms of a change from a base value. Thus, the percentage change is more important than the
actual numeric value.
Sub-index
A group of securities that is part of an index but is also tracked separately as a smaller,
separate index.
Types of indices
Stock market indices may be classed in many ways. A 'world' or 'global' stock market
index includes (typically large) companies without regard for where they are domiciled or
traded. Two examples areMSCI World and S&P Global 100 .
Types of Index
• Broad-Market Index:
This consists of all the large, liquid stocks of the country and becomes the benchmark for
the entire capital market of the country. An example for this is the S&P CNX 500.
• Specialized Index:
We can either have Industry or Sector specific Index for any particular sector of the
economy which then serves as the benchmark for that particular industry or we can havean index for the highly liquid stocks. Taking an example for an industry specific index we
have the S&P Banking Index which is a capitalization-weighted index of 26 domestic
equities traded on the New York Stock Exchange and NASDAQ, The stocks in the Indexare high-capitalization stocks representing a sector of the S&P 500. Similarly, The S&P
CNX Nifty is a relevant example for an index composed of highly liquid stocks
A national index
A national index represents the performance of the stock market of a given nation—and by proxy, reflects investor sentiment on the state of its economy. The most regularly
quoted market indices are national indices composed of the stocks of large companieslisted on a nation's largest stock exchanges, such as the American S&P 500 , the Japanese
Nikkei 225 , and the BritishFTSE 100 .
Market Value-Weighted Index
The most common type of index is called market value-weighted index. What this meansis that the index measures the total value of all the outstanding stock issued by the various
companies in the index. The reasoning behind a market value index such as the S&P500*, is that companies with larger capitalizations or value will have a larger weighting
in the index and will “count more” than smaller companies. It would not make sense for
a very small company to have the same weighting in an index as a large company such asIBM. One of the drawbacks of a market-weighted index is that sometimes one company
or one type of industry can make up a very large portion of the index. In the technology
bubble of the late 90’s, the tech portion of most broad based indices became quitedominant.
Another less common type of index is called price-weighted. . This means that the index
is calculated using a stock price instead of the company value. The big problem with this
type of index is that a company that has a stock price of $100 will count twice as much asa company with a stock price of $50. There is a formula used to calculate these type of indices to account for stock splits indexes, aside from giving overall grades to particular
economies, can also be used as investment instruments. Mutual funds which are based onindexes are called passively managed mutual funds.
Determinants of a Stock Index
Following parameters should be taken into picture before one constructs a stock index:
• Liquidity –
Liquidity of stocks as measured by the “impact cost” criterion which determines the costfaced when actually trading the index. For example if the current market price of a stock
is Rs 200 and a trader purchases it at Rs 202 (due to involved transaction costs) then themarket impact cost is 1% and the stock is considered highly liquid for lower impact cost.
EG.
• Diversification –
Diversification, by putting stocks of various sectors that reflect the economy, is used to
cancel out stock noise which is essentially the individual stock fluctuations and to reduceinvestor’s risks. An index must thus have a balanced representation of all sectors.
• Optimum size –
More stocks lead to greater diversification but the limiting factor is the size of the index.Increasing number of stocks in an index from 10 to say 30 gives a sharp reduction in risks
but increasing the number beyond a point does very little in risk reduction. Further itmight lead to addition of illiquid stocks. For example, the optimal size for BSE Sensex is
funds that passively invest in the market i.e. the portfolio returns of the index funds issame as that of the Index. Since the Index is an indicator of the overall mood of the
investors in the secondary market, it helps a company answer questions like is it the righttime to take out an IPO, how to price the issue, etc.It acts as a signal to the government of
the ‘feel good’ factor prevailing in the economy. As much as the finance ministry may
want to ignore it, the performance of the stock market right after the introduction of the budget gives an immediate feedback to the Finance Minister about the acceptability of
the budget. However, the market index is a double edged sword. Because the index isinfluenced by expectations of the future performance of the stocks, it leads to a self
fulfilling prophecy. Suppose an investor thinks that the stock of the company is going togo down and this feeling prevails across the market then everyone would want to get out
of the company’s stock. This will automatically lead to the stock prices crashing. TheStock Index can often also act as a trigger to herd mentality. Any downturn in the market
would be reinforced by the collective action of the investors to hedge against any lossesand get out of the market. This would further depress the market. This herd mentality is
often used to the advantage of speculators. The speculator buys long thus creating waves
in the market that the stock he is investing in is ‘hot’. Thus everyone would follow suitgiving the speculator a good short term profit margin. The stock index is often more a
representation of investors’ perceptions (noise element) rather than real news. The dotcom bubble of 2000 is a case in point. There was a rush of investment in anything even
remotely connected with information-technology driving up the stock prices way abovewhat they should have been according to their P/E ratios. Thus it can be seen that though
the index is a popular investor’s guide, it is riddled with imperfections which can oftenconfuse rather than help. The index popularly used in India is the NSE CNX Nifty. There
are processes afoot to reduce the pure noise element and speculative margin of the index.The basic problem arises due to imperfect information reflected by the inclusion of
illiquid stocks in the calculation of the index. Illiquid stock is one which is not activelytraded in the market or has been lying dormant for a long time. Inclusion of such stocks
leads to problems of stale prices, bid-ask bounce and ease in manipulation.
Illiquid stocks have a wide bid-ask spread. Thus even when no news is breaking, when astock price is not changing, the `bid-ask bounce' is about prices bouncing up and down
between bid and ask. Such changes are spurious in nature.
State prices:
A stock index is supposed to represent the state of the stock market at the closing time(3:30pm in NSE) on a particular day. However the last traded price of an illiquid stock (if
included in the index) may be even a week old thus distorting the index. Hence to makean index useful, there has to be continuous evaluation of the stocks listed and any stock
which remains inactive for a period of time should be de-listed or removed from theindex. A prudent investor is one who exercises caution while interpreting the market
index, taking into account all its inconsistencies.
BSE Sensex or Bombay Stock Exchange Sensitive Index is a value-weighted index
composed of 30 stocks that started January 1, 1986. It consists of the 30 largest and most
actively traded stocks, representative of various sectors, on the Bombay Stock
Exchange . These companies account for around one-fifth of the market capitalization of the BSE. The base value of the sensex is 100 on April 1, 1979, and the base year of BSE-
At irregular intervals, the Bombay Stock Exchange (BSE) authorities review and modifyits composition to make sure it reflects current market conditions. The index is calculated
based on afree-float capitalization method; a variation of the market cap method. Insteadof using a company's outstanding shares it uses its float, or shares that are readily
available for trading. The free-float method, therefore, does not include restricted stocks,
such as those held by promoters, government and institutional investors.
The index has increased by over ten times from June 1990 to the present. Using
information from April 1979 onwards, the long-run rate of return on the BSE Sensexworks out to be 18.6% per annum, which translates to roughly 9% per annum after
SENSEX, first compiled in 1986, was calculated on a "Market Capitalization-Weighted"
methodology of 30 component stocks representing large, well-established and financiallysound companies across key sectors. The base year of SENSEX was taken as 1978-79.
SENSEX today is widely reported in both domestic and international markets through print as well as electronic media. It is scientifically designed and is based on globally
accepted construction and review methodology. Since September 1, 2003, SENSEX is being calculated on a free-float market capitalization methodology. The "free-float market
capitalization-weighted" methodology is a widely followed index constructionmethodology on which majority of global equity indices are based; all major index
providers like MSCI, FTSE, STOXX, S&P and Dow Jones use the free-floatmethodology.
The growth of the equity market in India has been phenomenal in the present decade.
Right from early nineties, the stock market witnessed heightened activity in terms of various bull and bear runs. In the late nineties, the Indian market witnessed a huge frenzy
in the 'TMT' sectors. More recently, real estate caught the fancy of the investors. SENSEXhas captured all these happenings in the most judicious manner. One can identify the
booms and busts of the Indian equity market through SENSEX. As the oldest index in thecountry, it provides the time series data over a fairly long period of time (from 1979
onwards). Small wonder, the SENSEX has become one of the most prominent brands in
Launched on full market capitalization method and effective Septembe
calculation method shifted tofree-float market capitalization .Number of
scrips
30
Companies in the Sensex
List of BSE Sensex companies provides the full list of companies that have been part of the BSE Sensex since its inception in 1986 (baselined to 1979).
(as of June 29, 2009)
Code Name SectorAdj.
Factor
500410 ACC Housing Related 0.55500103 BHEL Capital Goods 0.35532454 Bharti Airtel Telecom 0.35532868 DLF Universal Limited Housing related 0.25500300 Grasim Industries Diversified 0.75500010 HDFC Finance 0.90500180 HDFC Bank Finance 0.85500182 Hero Honda Motors Transport Equipments 0.50
S&P CNX Nifty is owned and managed byIndia Index Services and Products Ltd. (IISL),which is a joint venture between NSE and CRISIL. IISL is India's first specialised company
focused upon the index as a core product. IISL has a Marketing and licensing agreement withStandard & Poor's (S&P), who are world leaders in index services.
• The total traded value for the last six months of all Nifty stocks is approximately 54%of the traded value of all stocks on the NSE
• Nifty stocks represent about 62.50% of the Free Float Market Capitalization as onSept 30, 2009.
• Impact cost of the S&P CNX Nifty for a portfolio size of Rs.2 crore is 0.16%• S&P CNX Nifty is professionally maintained and is ideal for derivatives trading
From June 26, 2009, S&P CNX Nifty is computed based on free float methodology. 20
1. PRIMARY DATA: The information which is been collected directly from the
resources is called primary data. The data that is available with us is been
received from internet, books, news paper, magazines, etc. which have beenmentioned in the bibliography. There is no primary information (data) with the
researcher.
2. SECONDARY DATA: The data has been collected referring books,
bulletines, facts information. To achive the exactness in the information
SENSEX is calculated using the "Free-float Market Capitalization" methodology,
wherein, the level of index at any point of time reflects the free-float market value of 30component stocks relative to a base period. The market capitalization of a company is
determined by multiplying the price of its stock by the number of shares issued by thecompany. This market capitalization is further multiplied by the free-float factor to
determine the free-float market capitalization.
The base period of SENSEX is 1978-79 and the base value is 100 index points. This is
often indicated by the notation 1978-79=100. The calculation of SENSEX involves
dividing the free-float market capitalization of 30 companies in the Index by a number called the Index Divisor. The Divisor is the only link to the original base period value of
the SENSEX. It keeps the Index comparable over time and is the adjustment point for allIndex adjustments arising out of corporate actions, replacement of scrips etc. During
market hours, prices of the index scrips, at which latest trades are executed, are used bythe trading system to calculate SENSEX on a continuous basis.
BSE also calculates a dollar-linked version of SENSEX and historical values of thisindex are available since its inception. (For more details click 'Dollex series of BSE
indices' )
SENSEX - Scrip Selection Criteria
The general guidelines for selection of constituents in SENSEX are as follows:
1. Listed History:
The scrip should have a listing history of at least 3 months at BSE.
Exception may be considered if full market capitalization of a newly listedcompany ranks among top 10 in the list of BSE universe. In case, a company is
listed on account of merger/ demerger/ amalgamation, minimum listing history
would not be required.2. Trading Frequency:
The scrip should have been traded on each and every trading day inthe last three months at BSE. Exceptions can be made for extreme reasons like
The scrip should figure in the top 100 companies listed by final rank. The
final rank is arrived at by assigning 75% weightage to the rank on the basis of three-month average full market capitalization and 25% weightage to the
liquidity rank based on three-month average daily turnover & three-month
average impact cost.
4. Market Capitalization Weightage:
The weightage of each scrip in SENSEX based on three-month average
free-float market capitalization should be at least 0.5% of the Index.
5. Industry/Sector Representation:Scrip selection would generally take into account a balanced
representation of the listed companies in the universe of BSE.
6. Track Record:
In the opinion of the BSE Index Committee, the company should have anacceptable track record.
Free-float methodology refers to an index construction methodology that takes intoconsideration only the free-float market capitalization of a company for the purpose of
index calculation and assigning weight to stocks in the index. Free-float marketcapitalization takes into consideration only those shares issued by the company that are
readily available for trading in the market. It generally excludes promoters' holding,
government holding, strategic holding and other locked-in shares that will not come tothe market for trading in the normal course. In other words, the market capitalization of
each company in a free-float index is reduced to the extent of its readily available sharesin the market.
Subsequently all BSE indices with the exception of BSE-PSU index have adopted the
free-float methodology.
Major advantages of Free-float Methodology
• A Free-float index reflects the market trends more rationally as it takes intoconsideration only those shares that are available for trading in the market.
• Free-float Methodology makes the index more broad-based by reducing the
concentration of top few companies in Index.
• A Free-float index aids both active and passive investing styles. It aids active
managers by enabling them to benchmark their fund returns vis-Ã -vis aninvestible index. This enables an apple-to-apple comparison thereby facilitating
better evaluation of performance of active managers. Being a perfectly replicable portfolio of stocks, a Free-float adjusted index is best suited for the passive
managers as it enables them to track the index with the least tracking error.
• Free-float Methodology improves index flexibility in terms of including any stock from the universe of listed stocks. This improves market coverage and sector
coverage of the index. For example, under a Full-market capitalization
methodology, companies with large market capitalization and low free-float
cannot generally be included in the Index because they tend to distort the index byhaving an undue influence on the index movement. However, under the Free-float
Methodology, since only the free-float market capitalization of each company isconsidered for index calculation, it becomes possible to include such closely-held
companies in the index while at the same time preventing their undue influence
on the index movement.
• Globally, the Free-float Methodology of index construction is considered to be anindustry best practice and all major index providers like MSCI, FTSE, S&P and
STOXX have adopted the same. MSCI, a leading global index provider, shiftedall its indices to the Free-float Methodology in 2002. The MSCI India Standard
Index, which is followed by Foreign Institutional Investors (FIIs) to track Indianequities, is also based on the Free-float Methodology. NASDAQ-100, the
underlying index to the famous Exchange Traded Fund (ETF) - QQQ is based onthe Free-float Methodology.
Definition of Free-float
Shareholding of investors that would not, in the normal course come into the open marketfor trading are treated as 'Controlling/ Strategic Holdings' and hence not included in free-float. Specifically, the following categories of holding are generally excluded from the
definition of Free-float:
• Shares held by founders/directors/ acquirers which has control element
• Shares held by persons/ bodies with "Controlling Interest"
• Strategic stakes by private corporate bodies/ individuals
• Equity held by associate/group companies (cross-holdings)
• Equity held by Employee Welfare Trusts
• Locked-in shares and shares which would not be sold in the open market in
normal course.
Determining Free-float Factors of Companies
BSE has designed a Free-float format, which is filled and submitted by all indexcompanies on a quarterly basis.. BSE determines the Free-float factor for each company
based on the detailed information submitted by the companies in the prescribed format.Free-float factor is a multiple with which the total market capitalization of a company is
adjusted to arrive at the Free-float market capitalization. Once the Free-float of acompany is determined, it is rounded-off to the higher multiple of 5 and each company is
categorized into one of the 20 bands given below. A Free-float factor of say 0.55 meansthat only 55% of the market capitalization of the company will be considered for index
The closing SENSEX on any trading day is computed taking the weighted average of all
the trades on SENSEX constituents in the last 30 minutes of trading session. If aSENSEX constituent has not traded in the last 30 minutes, the last traded price is taken
for computation of the Index closure. If a SENSEX constituent has not traded at all in aday, then its last day's closing price is taken for computation of Index closure. The use of
Index Closure Algorithm prevents any intentional manipulation of the closing indexvalue.
Maintenance of SENSEX
One of the important aspects of maintaining continuity with the past is to update the baseyear average. The base year value adjustment ensures that replacement of stocks in Index,
additional issue of capital and other corporate announcements like 'rights issue' etc. donot destroy the historical value of the index. The beauty of maintenance lies in the fact
that adjustments for corporate actions in the Index should not per se affect the indexvalues.
The BSE Index Cell does the day-to-day maintenance of the index within the broad index policy framework set by the BSE Index Committee. The BSE Index Cell ensures thatSENSEX and all the other BSE indices maintain their benchmark properties by striking a
delicate balance between frequent replacements in index and maintaining its historical
continuity. The BSE Index Committee comprises of capital market expert, fundmanagers, market participants and members of the BSE Governing Board.
On-Line Computation of the Index
During trading hours, value of the Index is calculated and disseminated on real time
basis. This is done automatically on the basis of prices at which trades in Indexconstituents are executed.
Adjustment for Bonus, Rights and Newly Issued Capital
SENSEX calculation needs to be adjusted for issue of Bonus or Rights shares If noadjustments were made, a discontinuity would arise between the current value of the
index and its previous value despite the non-occurrence of any economic activity of substance. At the BSE Index Cell , the base value is adjusted, which is used to alter
market capitalization of the component stocks to arrive at the SENSEX value.
The BSE Index Cell keeps a close watch on the events that might affect the index on aregular basis and carries out daily maintenance of all the 19 Indices.
• Adjustments for Rights Issues
When a company, included in the compilation of the index, issues right shares, the
free-float market capitalization of that company is increased by the number of additional shares issued based on the theoretical (ex-right) price. An offsetting or
proportionate adjustment is then made to the Base Market capitalization (see'Base Market capitalization Adjustment' below).
• Adjustments for Bonus Issue
When a company, included in the compilation of the index, issues bonus shares,
the market capitalization of that company does not undergo any change.33
Therefore, there is no change in the Base Market capitalization, only the 'number of shares' in the formula is updated.
• Other Issues
Base Market capitalization adjustment is required when new shares are issued by
way of conversion of debentures, mergers, spin-offs etc. or when equity isreduced by way of buy-back of shares, corporate restructuring etc.
• Base Market capitalization Adjustment
The formula for adjusting the Base Market capitalization is as follows:
New Mkt. Cap.
New Base Mkt. Cap. = Old Base Mkt. Cap. x ---------------------------------------Old Mkt. Cap
For Example:
Suppose a company issues right shares which increases the market capitalization of theshares of that company by say, Rs.100 crores. The existing Base Market capitalization
(Old Base Market capitalization), say, is Rs.2450 crores and the aggregate marketcapitalization of all the shares included in the index before the right issue is made is, say
Rs.4781 crore. The "New Base Market capitalizaton " will then be:
New Base Mkt. Cap = 2450 X ---------------------------------
4781
= 2501.24 crores
This figure of Rs. 2501.24 crore will be used as the Base Market capitalization for
calculating the index number from then onwards till the next base change becomesnecessary.
Index Review Frequency
The BSE Index Committee meets every quarter to discuss index related issues. In case of
a revision in the Index constituents, the announcement of the incoming and outgoingscrips is made six weeks in advance of the actual implementation of the revision of theIndex.
S&P CNX Nifty is computed using market capitalization weighted method, wherein thelevel of the index reflects the total market value of all the stocks in the index relative to a
particular base period. The method also takes into account constituent changes in theindex and importantly corporate actions such as stock splits, rights, etc without affecting
the index value.
Base Date and Value
The base period selected for S&P CNX Nifty index is the close of prices on November 3,1995, which marks the completion of one year of operations of NSE's Capital Market
Segment. The base value of the index has been set at 1000 and a base capital of Rs.2.06trillion.
Criteria for Selection of Constituent Stocks
The constituents and the criteria for the selection judge the effectiveness of the index.Selection of the index set is based on the following criteria:
For inclusion in the index, the security should have traded at an average impact cost of 0.50% or less during the last six months for 90% of the observations for a basket size of
Rs. 2 Crores.
Impact cost is cost of executing a transaction in a security in proportion to the weightage
of its market capitalisation as against the index market capitalisation at any point of time.This is the percentage mark up suffered while buying / selling the desired quantity of a
security compared to its ideal price (best buy + best sell) / 2
Floating Stock
Companies eligible for inclusion in S&P CNX Nifty should have atleast 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) 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 capitalizationand floating stock, for a 3 month period instead of a 6 month period.
A stock may be replaced from an index for the following reasons:
(i) Compulsory changes like corporate actions, delisting etc. In such a scenario, the
stock having largest market capitalization and satisfying other requirementsrelated to liquidity, turnover and free float will be considered for inclusion.
(ii) When a better candidate is available in the replacement pool, which can replace
the index stock i.e. the stock with the highest market capitalization in thereplacement pool has at least twice the market capitalization of the index stock
with the lowest market capitalization.
With respect to (2) above, a maximum of 10% of the index size (number of stocks in theindex) may be changed in a calendar year. Changes carried out for (2) above are
irrespective of changes, if any, carried out for (1) above.
From June 26, 2009, S&P CNX Nifty is computed using Free Float Market
Capitalisation weighted method, wherein the level of index reflects the free float
market capitalisation of all stocks in Index.
Index Maintenance
Index Maintenance plays a crucial role in ensuring stability of the Index as well as in
meeting its objective of being a consistent benchmark of the equity markets.
IISL has constituted anIndex Policy Committee , which is involved in policy andguidelines for managing the CNX Indices. TheIndex Maintenance Sub-committee
takes all decisions on addition/ deletion of companies in any Index.
The index is reviewed every six months (on half-yearly basis) and a six weeks’ notice isgiven to the market before making changes to the index set.
Hedging Effectiveness
Exhaustive calculations have been carried out to determine the hedging effectiveness of
the 50-security index S&P CNX NIFTY against numerous randomly chosen equally-weighted portfolios of different sizes varying from 1 to 100 of smallcap, midcap and
largecap companies as well as many industry indices/sub-indices provided by CMIE. Itwas observed that the correlation (R2) for various portfolios and indices using monthly
returns data on the S&P CNX Nifty vis-a-vis other indices was significantly higher indicating that the S&P CNX Nifty had higher hedging effectiveness.