Advantages of Free-Float market capitalization method

A market index should reflect the market movements. Since the index funds follow a market index, it should consider only liquid scrips and the active portion of the outstanding shares so that it reflects the market conditions in a better way. So free-float market capitalization method of calculating index value is suitable.

Passive investments such as foreign direct investments are easily replicable. It aids in index flexibility and covers overall market (for market indices) and sectors (for sector indices). It avoids the undue influence of any closely-held (i.e. more promoter holding) large-capitalization stock on the index movement. Read more

January 17, 2009 | Filed Under Fundamental Analysis | Leave a Comment

Actual Sensex Calculation – Free float Market Capitalization

We have already discussed different types of stock market indices. Market capitalization is the most common method across the world. The market capitalization method we covered is ‘Full Market Capitalization method’. But in reality, in most of the markets, Full Market Capitalization is not used for calculating market index values. At any time only a part of the total market capitalization is readily available for trading in the market. This is because promoters’ holding, government holding, strategic holding and other locked-in shares will not be available in the market for trading in the normal course.

A company provides the holdings information to the exchanges periodically. The exchanges calculate free-float factor as follows

(No. of shares readily available for trading in the market) / (Total number of shares outstanding) Read more

January 17, 2009 | Filed Under Stocks | Leave a Comment

scrip selection criteria for an Index - Sensex/Nifty

Criteria for selecting stocks of a market index:

1.    Diversification.
2.    Market Capitalization
3.    Liquidity

Diversification: An index should represent the overall market. So the constituents are picked from different sectors. At the time of creating an index they consider the sectors which contributed to the growth of the economy. There would be no benefit if they include stocks of undeveloped sectors. Beyond a certain point adding more stocks would bring zero benefit. That’s why there are no aviation companies in Sensex. In recent years there has been a significant improvement in this sector. In future we can expect a representation from this sector; may not be addition to the existing 30 shares but as a replacement to other stock. We have seen this kind of replacement when DLF was added in place of Dr Reddy’s labs. So they select developed sectors and finalize the number of stocks in an index. This number doesn’t get changed most of the times. Read more

January 3, 2009 | Filed Under Stocks | Leave a Comment

Types of Stock market indexes - Sensex Nifty calculation

There are three different types of stock indexes.

Market capitalization weighted index
Price weighted index
Equally weighted index

Market capitalization based index is the famous one among the above and is used by most of the exchanges world wide. BSE Sensex and NSE NIFTY are calculated based on the method of market capitalization weight.

Market capitalization weighted index: In this method of calculation each company is given weight according to their market capitalization. So the higher the market capitalization of a constituent higher is its weight in the index.

For simplicity assume there are only 5 constituents in an index. A base value will be taken to calculate present value of the index. Usually this base value corresponds to prices of the constituent stocks on a particular historic date. For this example, say as at April 3rd 2000. I didn’t take April 1st because you may think I am fooling you Take the base value as 1000. Read more