SENSEX is a scientifically designed and globally accepted construction and review methodology. First compiled in 1986, SENSEX is a basket of 30 constituent stocks representing a sample of large, liquid and representative companies. The base year of SENSEX is 1978-79 and the base value is 100. The index is widely reported in both domestic and international markets through print as well as electronic media.
The Index was initially calculated based on the "Full Market Capitalization" methodology but was shifted to the free-float methodology with effect from September 1, 2003. The "Free-float Market Capitalization" methodology of index construction is regarded as an industry best practice globally. All major index providers like MSCI, FTSE, STOXX, S&P and Dow Jones use the Free-float methodology.
To understand the terms 'Full market capitalization' and 'Free-float market capitalization' we need to know what is 'market capitalization.'
Market cap or market capitalization is simply the worth of a company in terms of its shares! To put it in a simple way, if you were to buy all the shares of a particular company, what is the amount you would have to pay? That amount is called the “market capitalization”! To calculate the market cap of a particular company, simply multiply the “current share price” by the “number of shares issued by the company.”
But then can one buy 'all' the shares of a company? It is impossible, because, all the shares of a company are not available for trade. BSE for instance enumerates 'free-float shares' as those not belonging to any of the following categories:
· Holdings by founders/directors/ acquirers which has control element
· Holdings by persons/ bodies with "controlling interest"
· Government holding as promoter/acquirer
· Holdings through the
· 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.
A company has to submit a complete report about “who has how many of the company’s shares” to the BSE. On the basis of this, the BSE will decide the “free-float factor” of the company. The “free-float factor” is a very valuable number! If you multiply the "free-float factor" with the “market cap” of that company, you will get the “free-float market cap” which is the value of the shares of the company in the open market!
How do you find out the value of the Sensex at a particular point? In three simple steps: First, find out the “free-float market cap” of all the 30 companies that make up the Sensex. Then add all the “free-float market caps” of all the 30 companies. And finally make all this relative to the Sensex base. The value you get is the Sensex value. Sounds simple eh?
Now, there is only one question left to be answered, which 30 companies, why those 30 companies, why no other companies? The 30 companies that make up the Sensex are selected and reviewed from time to time by an “index committee”. This “index committee” is made up of academicians, mutual fund managers, finance journalists, independent governing board members and other participants in the financial markets.
The main criteria for selecting the 30 stocks is as follows:
1. Market capitalization: The company should have a market capitalization in the Top 100 market capitalization’s of the BSE. Also the market capitalization of each company should be more than 0.5% of the total market capitalization of the Index.
2. Trading frequency: The company to be included should have been traded on each and every trading day for the last one year. Exceptions can be made for extreme reasons like share suspension etc.
3. Number of trades: The scrip should be among the top 150 companies listed by average number of trades per day for the last one year.
4. Industry representation: The companies should be leaders in their industry group.
5. Listed history: The companies should have a listing history of at least one year on BSE.
6. Track record: In the opinion of the index committee, the company should have an acceptable track record.
NSE S&P CNX Nifty
As with the BSE sensex, other indices also are constructed worldwide in a similar way; with some variations in their computation ofcourse.
For instance our own NSE -- National Stock Exchange, the larger of the two stock exchanges in the country, uses its own index called NSE S&P CNX Nifty. This index is a well diversified 50 stock index accounting for 24 sectors of the economy. It is used for a variety of purposes such as benchmarking fund portfolios, index based derivatives and index funds.
Something about the long name of this index. NSE stands for the "National Stock Exchange." S&P (Standard & Poor) is a leading company in the world in offering indexing services. The CNX in its name stands for 'CRISIL NSE Indices'. The X in CNX represents the x in the word 'IndeX' or ‘Exchange.’ Nifty represents the 'NSE fifty' stocks.
It is calculated as a weighted average, so changes in the share price of larger companies have more effect. The base is defined as 1000 at the price level of November 3, 1995.
Will all this learning be useful for us in Civils? I doubt it about its direct help. But it would give you a reasonable understanding of how an index is constructed. As I always say, an extensive base is usually required for attempting the GS paper.