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.
Stock price as at
Stock price as at
Market capitalization = No.of Shares * Market Price
Sum of the market capitalization of all constituent stocks as at April 3rd 2000 = (150*20 + 300*12 + 450*16 + 70*30 + 270 *8) = Rs 18,060 million.
Sum of the market capitalization of all constituent stocks as at January 2nd 2009 = (800*20 + 450*12 + 420*16 + 500*30 + 820 *8) = Rs 49,680 million.
Now the value of the index as per market cap weight = (49680*1000/18060) = 2750
So as the price of these constituent scrips change the index value changes.
If the exchange decides to replace an existing constituent with another stock then the sum of market value of constituent stocks get changed. So they adjust the base price to nullify that effect.
Price weighted index: In price weighted index method index value is calculated based on the price of constituent stock.
So the value of index by this method = (800 + 450 + 420 + 500 + 820) * 1000 / (150 + 300 + 450 + 70 + 270) = 1240 * 1000/2990 = 2411
Note: The methods described may not exactly match with the real time calculations.ADVERTISEMENTS