Guide To Investing In Stock Market (Part III)

Introducing The Indian Indices- BSE Sensex and the S&P CNX Nifty

The BSE is the Stock exchange that pioneered the stock broking activity in India in 1875. The stock market through its life since inception has seen a lot of ups and downs, but till 1986, there was no measure to quantify these ups or downs. This is when the BSE Sensex was compiled in 1986. Trading on the NSE began in 1994. In 1998, NSE and CRISIL formed a JV named India Index Services & Products Ltd. (IISL), which was formed with the objective of concentrating on the formation and maintenance of only indices as a product of this JV. This is when the CNX Nifty was launched, where CNX stands for CRISIL NSE Indices. This index is owned by IISL. Later on Standard & Poor’s, which owns the S&P 500 Index endorsed the CNX Nifty and then it begun to be called as the S&P CNX Nifty.

The BSE Sensex

SENSEX, first compiled in 1986 is an attempt to capture three characteristics for a constituent. They are (1) size-It has to be a large company, (2) Liquidity-It has to be a highly liquid stock and (3) Representation- Most prominent, if not all sectors, should be portrayed amongst the constituents. The Sensex consists of 30 scrips as an ideal portfolio and is calculated on a "Market Capitalization-Weighted" with base year 1978-79. Originally, the Sensex was calculated on a full market cap, but was then amended to include only free float market cap of the company. Free-float market capitalization is defined as that proportion of total shares issued by the company that are readily available for trading in the market. It generally excludes promoters’ holding, government holding, strategic holding and other locked-in shares that will not come to the market for trading in the normal course. The level of index at any point of time reflects the Free-float market value of 30 component stocks relative to the base period. The base value of SENSEX is 100 index points. The calculation of SENSEX involves dividing the Free-float 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 adjustments arising out of corporate actions, replacement of scrips etc. For scrip to be a part of the Sensex, it should be

1. Listed on the BSE for at least three months
2. Traded on each and every day of the last three months
3. In the Top 100 Companies listed by final rank
4. Having a weight age of at least 0.5% of the Index based on three-month average free-float market capitalization
5. Representing the listed companies in the universe of the BSE and
6. Having an acceptable track record

The S&P CNX Nifty

The S&P CNX Nifty is a scientifically prepared index and has certain rules for scrip to be a part of the index. These rules are very different relative to the Sensex. After almost a trillion calculations, it was found that the correct size of a portfolio in India is 50 scrips. This is the basis of Nifty having 50 stocks as opposed to 30 stocks in the Sensex. The main criteria of a stock being a part of this portfolio is the impact cost criteria. Impact Cost, whereby means that the stock should have a minimal impact on the CMP of the scrip even when bought in a good quantity. The following is an example to explain the term, “Impact Cost”. Suppose a stock trades at bid 99 and ask 101. We say the "ideal" price is Rs. 100. Now, suppose a buy order for 1000 shares goes through at Rs.102. Then we say the market impact cost at 1000 shares is 2%. If a buy order for 2000 shares goes through at Rs.104, we say the market impact cost at 2000 shares is 4%. Market impact cost is the best measure of the liquidity of a stock. It accurately reflects the costs faced when actually trading an index. For a stock to qualify for possible inclusion into the S&P CNX Nifty, it has to reliably have market impact cost of below 0.75 % when doing S&P CNX Nifty trades of Rs 5 mn. Based on this the 50 largest stocks fulfilling this criteria make up the Nifty.

Conclusively therefore, both the indices have their own importance and own ideologies of construction. However, both having their own ideologies have had very few chances of different opinion about the health of the broad market. These two indicators are broad indicators of the market. There are also available indices specific to sector, market capitalization, etc., which give a more close and accurate indication.