Know About SENSEX - Online Article

The SENSEX, An abbreviation of the Bombay Exchange Sensitive Index (SENSEX), is a "Market
Capitalization-Weighted" index of 30 stocks representing a sample of large, well-established and financially sound companies. It is the oldest index in India and has acquired a unique place in  the collective consciousness of investors. The index is widely used to measure the performance of the Indian stock markets. 

SENSEX is considered to be the pulse of the Indian stock markets as it represents the underlying universe of listed stocks at The Stock Exchange, Mumbai. Further, as the oldest index of the Indian Stock market, it provides time series data over a fairly long period of time
(since 1978-79). The index has just one job: To capture the price movement. So a stock index will reflect the price movements of shares while a bond index captures the manner in which 
bond prices go up or down.

If the SENSEX rises, it indicates the market is doing well. Since stocks are supposed to reflect
what companies expect to earn in the future, a rising index indicates investors expect better 
earnings from companies. It is, therefore, also a measure of the state of the Indian economy. If Indian companies are expected to do well, obviously the economy should do well too.

Selection of 30 stocks

They are selected by the Index Committee. This committee consists of all sorts of individuals
including academicians, mutual fund managers, finance journalists, independent governing
board members and other participants in the financial markets. Some of the selection criteria
they follow include:

  1. The stock should have been traded on each and every trading day (the days on which the stock market works) for the past one year.
  2. It should be among the top 150 companies listed by average number of trades (buying or selling of shares) and the average value of the trades (in actual rupee terms) per day over the past one year.
  3. The stock must have been listed on the BSE for at least one year.

Objectives of SENSEX

The SENSEX is the benchmark index of the Indian Capital Markets with wide acceptance among
individual investors, institutional investors, foreign investors and fund managers. The objectives of the index are:

To measure market movements

Given its long history and its wide acceptance, no other index matches the SENSEX in reflecting
market movements and sentiments. SENSEX is widely used to describe the mood in the Indian
Stock markets.

Benchmark for funds performance

The inclusion of blue chip companies and the wide and balanced industry representation in the
SENSEX makes it the ideal benchmark for fund managers to compare the performance of their
funds.

For index based derivative products

Institutional investors, money managers and small investors all refer to the SENSEX for their
specific purposes. The SENSEX is in effect the proxy for the Indian stock markets. The country's
first derivative product i.e. Index-Futures was launched on SENSEX.

Criteria for selection and review of scrips for the SENSEX

A. Quantitative Criteria

1. Market Capitalization

The scrip should figure in the top 100 companies listed by market capitalization. Also market
capitalization of each scrip should be more than 0.5 % of the total market capitalization of the
Index i.e. the minimum weight should be 0.5 %. Since the SENSEX is a market capitalization weighted index, this is one of the primary criteria for scrip selection. (Market Capitalization
would be averaged for last six months).

To find the free-float capitalization of a company, first find its market cap (number of outstanding shares x share price) then multiply its free-float factor. The free-float factor is determined by the percentage of floated shares to outstanding. For example, if a company has
a float of 10 million shares and outstanding shares of 12 million, the percent of float to outstanding is 83%. A company with an 83% free floats falls in the 80-85% free-float factor, or 0.85, which is then multiplied by its market cap (e.g. $120 million (12 million shares x $10/share) x 0.85 = $102 million free-float capitalization).

2. Liquidity
  1. Trading Frequency: The scrip should have been traded on each and every trading day for the last one year. Exceptions can be made for extreme reasons like scrip suspension etc.
  2. 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.
  3. Value of Shares Traded: The scrip should be among the top 150 companies listed by
    average value of shares traded per day for the last one year.

3. Continuity

Whenever the composition of the index is changed, the continuity of historical series of index
values is re-established by correlating the value of the revised index to the old index (index before revision). The back calculation over the last one-year period is carried out and correlation of the revised index to the old index should not be less than 0.98. This ensures that the historical continuity of the index is maintained.

4. Industry Representation

Scrip selection would take into account a balanced representation of the listed companies in the universe of BSE. The index companies should be leaders in their industry group.

5. Listed History

The scrip should have a listing history of at least one year on BSE.

B. Qualitative Criteria

Track Record

In the opinion of the Index Committee, the company should have an acceptable track record.

Beta of SENSEX scrips

Beta measures the sensitivity of a scrip movement relative to movement in the benchmark index i.e. SENSEX. A Beta of one means that for every change of 1% in index, the scrip moves by 1%. Statistically Beta is defined as: Covariance (SENSEX, Stock) / Variance (SENSEX)
Note: Covariance and variance are calculated from the Daily Returns data of the SENSEX and
SENSEX scrips.

SENSEX calculation

SENSEX is calculated using a "Market Capitalization-Weighted" methodology. As per this methodology, the level of index at any point of time reflects the total market value of 30 component 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 the company). An index of a set of combined variables (such as price and number of shares) is commonly referred as a 'Composite Index' by statisticians. A single indexed number is used to represent the results of this calculation in order to make the value easier to work with and track over time. It is much easier to graph a chart based on indexed values than one based on actual values.

The base period of SENSEX is 1978-79. The actual total market value of the stocks in the Index
during the base period has been set equal to an indexed value of 100. This is often indicated by the notation 1978-79 = 100. The formula used to calculate the Index is fairly straightforward. However, the calculation of the adjustments to the Index (commonly called Index maintenance) is more complex.

The calculation of SENSEX involves dividing the total 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 all Index maintenance adjustments. During market hours, prices of the index scrips, at which latest trades are executed, are used by the trading system to calculate SENSEX every 15 seconds and disseminated in real time.

Calculation of closing Index

The closing SENSEX is computed taking the weighted average of all the trades on SENSEX constituents in the last 15 minutes of trading session. If a SENSEX constituent has not traded in the last 15 minutes, the last traded price is taken for computation of the Index closure. If a SENSEX constituent has not traded at all in a day, 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 index value.

SENSEX maintenance

One of the important aspects of maintaining continuity with the past is to update the base year average. The base year value adjustment ensures that additional issue of capital and other corporate announcements like bonus etc. do not destroy the value of the index. The beauty of maintenance lies in the fact that adjustments for corporate actions in the Index should not affect the index values.

The Index Cell of the Exchange does the day-to-day maintenance of the index within the broad index policy framework set by the Index Committee. The Index Cell takes special care to ensure that SENSEX and all the other BSE indices maintain their benchmark properties by striking a delicate balance between high turnover in Index scrips and its representative character. The Index Committee of the Exchange has experts from different field of finance related to the capital markets. They include Academicians, Fund-managers from leading Mutual Funds, Finance - Journalists, Market Participants, Independent Governing Board members, and
Exchange administration.

Bonus, Rights and newly issued Capital in SENSEX

The arithmetic calculation involved in calculating SENSEX is simple, but problem arises when one of the component stocks pays a bonus or issues rights shares. If no adjustments were made, a discontinuity would arise between the current value of the index and its previous value. The Index Cell of the Exchange periodically adjusts the base value to take care of such
corporate announcements.

Adjustments for Rights Issues

When a company, included in the compilation of the index, issues right shares, the market capitalisation 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 Capitalisation (see' Base Market Capitalisation Adjustment' below).

Adjustments for Bonus Issue

When a company, included in the compilation of the index, issues bonus shares, the market capitalisation of that company does not undergo any change. Therefore, there is no change in the Base Market Capitalisation, only the 'number of shares' in the formula is updated.

Other Issues

Base Market Capitalisation Adjustment is required when new shares are issued by way of
conversion of debentures, mergers, spin-offs etc. or when equity is reduced by way of
buy-back of shares, corporate restructuring etc.

Base Market Capitalisation Adjustment

The formula for this is as follows:

New Base Market Capitalisation = Old Base Market Capitalisation X (New Market Capitalisation/Old Market Capitalisation)

To illustrate, suppose a company issues right shares which increases the market capitalisation
of the shares of that company by say, Rs. 100 crores. The existing Base Market Capitalisation (Old Base Market Capitalisation), say, is Rs. 2450 crores and the aggregate market capitalisation of all the shares included in the index before the right issue is made is, say Rs. 4781 crores. The "New Base Market Capitalisation " will then be: Rs. 2501.24 crores = 2450 X
(4781+100)/4781

This figure of 2501.24 will be used as the Base Market Capitalisation for calculating the index number from then onwards till the next base change becomes necessary.

SENSEX Calculation

During market hours, prices of the index scrips, at which trades are executed, are automatically used by the trading computer to calculate the SENSEX every 15 seconds and continuously updated on all trading workstations connected to the BSE trading computer in real time.

Fluctuations

The price of every stock price increases or decreases for two possible reasons:

  1. News about the company, like a product launch, closure of a factory, the government providing tax or duty exemptions to the sector so more profits expected, a feud among the company's top bosses, etc. This will be stock specific news.
  2. News about the country, like testing a nuclear bomb, a terrorist attack, a budget announcement, etc. This will be called index news. The job of an index is mainly to capture the news about the country. This will reflect the movement of the stock market as a whole. A good index will only capture news that is common to all stocks in India.

SENSEX contemporaries

The SENSEX is the oldest index in the country. It was born in 1986.
In terms of popularity, the NIFTY follows close.

NIFTY

The National Stock Exchange has an index called the Nifty (officially called S&P CNX Nifty). This name can be credited to the 50 stocks that comprise its index. The Nifty has 50 stocks covering
24 sectors, as against 30 stocks and 13 sectors for the SENSEX. These 50 stocks account for around 60 percent of the market capitalisation.

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Comments

Dinesh Godge on 2010-09-20 19:37:14 wrote,

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