Stock Market Indices are the barometer of the stock market which mimic the stock market behaviour and help to determine the upward and downwards movements in the stock market.
The Stock Market Indices give a broad outline of the market movement and also represent the market. As it is not possible to track the price of each stock listed on the exchange several stock market indices like BSE-SENSEX, BS@-200, DOLLEX, NSE-50, CRISIL-500 etc. are used to estimate the trends in the stock market.
SENSEX is the Index for Top 30 companies in the Bombay Stock Exchange (BSE)
NIFTY is the Index of Top 50 companies in the National Stock Exchange (NSE)
A stock market Index may be a Price Index or a Wealth Index. A price index is simply the average of all share prices with a base year, while in a wealth index the prices are weighted by market capitalization and the base period values are adjusted for subsequent rights and bonus offers. While the price index reflects the general price movement of stocks in the market, the wealth index helps to estimate the real wealth created for shareholders over a period of time.
Usefulness of Stock Market Indices / Index
It helps to recognize the broad trends in the market
It can be used as a benchmark for evaluating an investor`s portfolio
It serves as a status report of the general economy
It helps investors to allocate funds rationally among various stocks
Index Funds and futures can be formulated with the help of indices
It helps stock analysts to estimate the future movements in the stock market.
Differences between Stock Market Indices
The number of stocks – It influences the behaviour of the index. The larger the no. of stock the more representative is the sample. SENSEX has 30 scrips, NIFTY has 50 scrips
The composition of the stocks – It reflects the market movement as well as some macro-economic changes. Scrips that have lost their value are dropped and replaced with another performing scrip. This makes the stock market indices more representative and efficient.
The weights – The weight assigned to each company`s scrips which have a significant influence on market movements. The indices are weighted with price or value. Hence the stocks with high price or value influence the index more than stocks with low value.
The Base Year – The closer the base year is to the current year the more effective is the index in reflecting changes in market movements .SENSEX – 1978-79, NIFTY – 1995
It is also called BSE Sensitivity Index. Base Year – 1978-79 and at that time of its inception it contained only private companies geared towards commodity production, but with time more and more private and public companies came into the market and representation was given to various industrial sectors such as services, telecom, consumer goods, FMGC, automobile etc. Only the top 30 scrips are used to compute the SENSEX.
The criteria adopted for selection of 30 shares are:
Industry representation – The index must capture a macro-industrial situation through price movements of individual scrips. Therefore the company`s scrip must reflect the present state of the industry.
Previous track record – the company must have an acceptable track record of good performance in terms of corporate governance and dividend payment. It must also have a listing history of at least 1 year on BSE.
Market Capitalization – Market capitalization indicates the true value of the stock. It equals no. of outstanding shares x price of share. The outstanding shares depend upon equity base. The scrip should be in the top 100 listed companies according to full market capitalization.
Liquidity – It is based on trading frequency. The scrip should have been traded on each and every trading day for last 1 year except for extreme reasons and must have a good trading frequency, average daily trades and average daily turnover.
Initially full market capitalization methodology was used, but since September 2003 Free Float Methodology is used. Under this only the free float market capitalization of the company is considered. Free float market capitalization of the company refers to the proportion of the total shares that are readily available for trading in the market. For this purpose the following holdings are excluded:
Holding of founders/directors/acquires which have control element
Holdings of persons/bodies with a controlling interest
Holdings as promoters
Holding through FDI
Strategic stakes by private corporate bodies/individuals
Equity held by employee welfare trust etc.
The free float factor is calculated for each company and multiplied by its market capitalization. A Free float factor of 50% means that only 50% of the market capitalization of the company is considered for the calculation of SENSEX.
The policy framework for SENSEX is set by the Index committee. It is monitored and revised by the Index cell of exchange.
It is also known as NSE-50 Index. The base year for NIFTY Index is 1995 and the base value of index is set at 1000. This Index was built by IIS (India Index Service Ltd) and CRISIL (Credit Rating Information Services of India) along with strategic Alliance of SOP ( Standard Poor Rating Service). It was formed with the following objectives:
To reflect market movements more accurately
To provide a tool for measuring portfolio returns in comparison to market returns for fund managers
To provide a basis for introducing index based derivatives
Features of NIFTY Index
The selection criteria for the nifty index are market capitalization and liquidity.
The NIFTY Index represents 45% of the total market capitalization.
The impact cost of NIFTY portfolios is less compared to other portfolios.
It provides best protection against inflation.
It is selected for derivative trading
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