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An Introduction to Indian Stock Market Index(s) —- SENSEX & NIFTY

Comments Off on An Introduction to Indian Stock Market Index(s) —- SENSEX & NIFTYPosted by on May 29, 2012

The time I invested since my student days, to Private Corporate Sector, and presently working with a public sector autonomous body, I got opportunity to interact with good number of individuals who either were aspiring to get into a B-School so that they can land up smoothly and get absorbed in the vacant Human Resource Positions/ existing Manpower Requirements of Corporate (Private or Public) Sector.

I met one more category of individuals [relevant to this write up], who were pursuing their Post Graduate Program at some institution or Master’s Degree Program at some University to earn their PG Diploma in Business Management or Master of Business Administration Degree.

Since at this level they happen to be very new, it is not expected of them to be expert enough to understand the complexity of Industrial and Corporate Sector. Often, I noticed that at this stage, they thought that Business Administration as probably something very near to (if, not synonymous to) knowledge domains called as Economics or Commerce.

The other component that they look as business is Stock Market Index [Sensex or NIFTY], as they often see numerous articles discussing the business scenario or economic scenario and relating these to Stock Market Index in or the other context. Specially, since 2008 onwards there has been so much volatility and lack of stability in markets that now they often make headlines in Political News Papers too.

I found them, often very curious, to learn what Stock Market Index is, how it is created, why it is there, how is it a reflection of economic scenario and many more questions of the similar kind.

The problem is that majority of such individuals, even after having earned their degree or diploma sometimes, are not aware of it. There is no use deliberating on issue that why it is so, as that is not the subject of this deliberation. So coming directly to the topic, and that is to explain the heads mentioned below:

1. History of BSE                             

2. Calculation Methodology                     

3. Scrip Selection Criteria                              

4. Free Float Methodology     

5. Definition of Free Float                           

6. Major Advantages of Free Float

7. History of NIFTY                    

8. Calculation Methodology                      

9. Scrip Selection Criteria

The same follows here onwards:

HISTORY OF BSE SENSEX

SENSEX, first compiled in 1986, was calculated on a ‘Market Capitalization-Weighted’ methodology of 30 component stocks representing large, well-established and financially sound companies across key sectors. The base year of SENSEX was taken as 1978-79. SENSEX today is widely reported in both domestic and international markets through print as well as electronic media. It is scientifically designed and is based on globally accepted construction and review methodology. Since September 1, 2003, SENSEX is being calculated on a free-float market capitalization methodology. The ‘free-float market capitalization-weighted’ methodology is a widely followed index construction methodology on which majority of global equity indices are based; all major index providers like MSCI, FTSE, STOXX, S&P and Dow Jones use the free-float methodology.

The growth of the equity market in India has been phenomenal in the present decade. Right from early nineties, the stock market witnessed heightened activity in terms of various bull and bear runs. In the late nineties, the Indian market witnessed a huge frenzy in the ‘TMT’ sectors. More recently, real estate caught the fancy of the investors. SENSEX has captured all these happenings in the most judicious manner. One can identify the booms and busts of the Indian equity market through SENSEX. As the oldest index in the country, it provides the time series data over a fairly long period of time (from 1979 onwards). Small wonder, the SENSEX has become one of the most prominent brands in the country.

 

CALCULATION METHODOLOGY

SENSEX is calculated using the ‘Free-float Market Capitalization’ methodology, wherein, the level of index at any point of time reflects the free-float 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. This market capitalization is further multiplied by the free-float factor to determine the free-float market capitalization.

The base period of SENSEX is 1978-79 and the base value is 100 index points. This is often indicated by the notation 1978-79=100. 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. During market hours, prices of the index scrips, at which latest trades are executed, are used by the trading system to calculate SENSEX on a continuous basis.

 

SCRIP SELECTION CRITERIA

The general guidelines for selection of constituents in SENSEX are as follows:

  • Equities of companies listed on Bombay Stock Exchange Ltd. (excluding companies classified in Z group, listed mutual funds, scrip suspended on the last day of the month prior to review date, scrips objected by the Surveillance department of the Exchange and those that are traded under permitted category) shall be considered eligible.
  • Listing History: The scrip should have a listing history of at least three months at BSE. An exception may be granted to one month, if the average free-float market capitalization of a newly listed company ranks in the top 10 of all companies listed at BSE. In the event that a company is listed on account of a merger / demerger / amalgamation, a minimum listing history is not required.
  • The scrip should have been traded on each and every trading day in the last three months at BSE. Exceptions can be made for extreme reasons like scrip suspension etc.
  • Companies that have reported revenue in the latest four quarters from its core activity are considered eligible.
  • From the list of constituents selected through Steps 1-4, the top 75 companies based on free-float market capitalisation (avg. 3 months) are selected as well as any additional companies that are in the top 75 based on full market capitalization (avg. 3 months).
  • The filtered list of constituents selected through Step 5 (which can be greater than 75 companies) is then ranked on absolute turnover (avg. 3 months).
  • Any company in the filtered, sorted list created in Step 6 that has Cumulative Turnover of >98%, are excluded, so long as the remaining list has more than 30 scrips.
  • The filtered list calculated in Step 7 is then sorted by free float market capitalization. Any company having a weight within this filtered constituent list of <0.50% shall be excluded.
  • All remaining companies will be sorted on sector and sub-sorted in the descending order of rank on free-float market capitalization.
  • Industry/Sector Representation: Scrip selection will generally attempt to maintain index sectoral weights that are broadly in-line with the overall market.
  • Track Record: In the opinion of the BSE Index Committee, all companies included within the SENSEX should have an acceptable track record.

 

UNDERSTANDING FREE FLOAT METHODOLOGY

Free-float methodology refers to an index construction methodology that takes into consideration only the free-float market capitalization of a company for the purpose of index calculation and assigning weight to stocks in the index. Free-float market capitalization takes into consideration only those 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. In other words, the market capitalization of each company in a free-float index is reduced to the extent of its readily available shares in the market.

Subsequently all BSE indices with the exception of BSE-PSU index have adopted the free-float methodology.

 

DEFINITION OF FREE FLOAT

Shareholding of investors that would not, in the normal course come into the open market for trading are treated as ‘Controlling/ Strategic Holdings’ and hence not included in free-float. Specifically, the following categories of holding are generally excluded from the definition of Free-float:

  • Shares held by founders/directors/ acquirers which has control element
  • Shares held by persons/ bodies with ‘Controlling Interest’
  • Shares held by Government as promoter/acquirer
  • Holdings through the FDI Route
  • 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.

 

MAJOR ADVANTAGES OF FREE FLOAT METHODOLOGY

  • A Free-float index reflects the market trends more rationally as it takes into consideration only those shares that are available for trading in the market.
  • Free-float Methodology makes the index more broad-based by reducing the concentration of top few companies in Index.
  • A Free-float index aids both active and passive investing styles. It aids active managers by enabling them to benchmark their fund returns vis-a -vis an investible index. This enables an apple-to-apple comparison thereby facilitating better evaluation of performance of active managers. Being a perfectly replicable portfolio of stocks, a Free-float adjusted index is best suited for the passive managers as it enables them to track the index with the least tracking error.
  • Free-float Methodology improves index flexibility in terms of including any stock from the universe of listed stocks. This improves market coverage and sector coverage of the index. For example, under a Full-market capitalization methodology, companies with large market capitalization and low free-float cannot generally be included in the Index because they tend to distort the index by having an undue influence on the index movement. However, under the Free-float Methodology, since only the free-float market capitalization of each company is considered for index calculation, it becomes possible to include such closely-held companies in the index while at the same time preventing their undue influence on the index movement.
  • Globally, the Free-float Methodology of index construction is considered to be an industry best practice and all major index providers like MSCI, FTSE, S&P and STOXX have adopted the same. MSCI, a leading global index provider, shifted all its indices to the Free-float Methodology in 2002. The MSCI India Standard Index, which is followed by Foreign Institutional Investors (FIIs) to track Indian equities, is also based on the Free-float Methodology. NASDAQ-100, the underlying index to the famous Exchange Traded Fund (ETF) – QQQ is based on the Free-float Methodology.

 

HISTORY OF NIFTY

S&P CNX Nifty is a well diversified 50 stock index accounting for 21 sectors of the economy. It is used for a variety of purposes such as benchmarking fund portfolios, index based derivatives and index funds.

S&P CNX Nifty is owned and managed by India Index Services and Products Ltd. (IISL), which is a joint venture between NSE and CRISIL. IISL is India’s first specialised company focused upon the index as a core product. IISL has a Marketing and Licensing Agreement with Standard & Poor’s (S&P), who are world leaders in index services.

  1. Traded value for the last six months of all Nifty stocks is approximately 44.89% of the traded value of all stocks on the NSE
  2. Nifty stocks represent about 58.64% of the total market capitalization as on March 31, 2008.
  3. Impact cost of the S&P CNX Nifty for a portfolio size of Rs.2 crore is 0.15%
  4.  S&P CNX Nifty is professionally maintained and is ideal for derivatives trading

CALCULATION METHODOLOGY

S&P CNX Nifty is computed using market capitalization weighted method, wherein the level of the index reflects the total market value of all the stocks in the index relative to a particular base period. The method also takes into account constituent changes in the index and importantly corporate actions such as stock splits, rights, etc without affecting the index value.

SCRIP SELECTION CRITERIA

The constituents and the criteria for the selection judge the effectiveness of the index. Selection of the index set is based on the following criteria:

Liquidity (Impact Cost)

For inclusion in the index, the security should have traded at an average impact cost of 0.50% or less during the last six months for 90% of the observations for a basket size of Rs. 2 Crores.

Impact cost is cost of executing a transaction in a security in proportion to the weightage of its market capitalisation as against the index market capitalisation at any point of time. This is the percentage mark up suffered while buying / selling the desired quantity of a security compared to its ideal price (best buy + best sell) / 2

Floating Stock

Companies eligible for inclusion in S&P CNX Nifty should have at least 10% floating stock. For this purpose, floating stock shall mean stocks which are not held by the promoters and associated entities (where identifiable) of such companies.

Others
a) A company which comes out with a IPO will be eligible for inclusion in the index, if it fulfills the normal eligibility criteria for the index like impact cost, market capitalisation and floating stock, for a 3 month period instead of a 6 month period.

b) Replacement of Stock from the Index:

A stock may be replaced from an index for the following reasons:

i. Compulsory changes like corporate actions, delisting etc. In such a scenario, the stock having largest market capitalization and satisfying other requirements related to liquidity, turnover and free float will be considered for inclusion.

ii. When a better candidate is available in the replacement pool, which can replace the index stock i.e. the stock with the highest market capitalization in the replacement pool has at least twice the market capitalization of the index stock with the lowest market capitalization.

With respect to (2) above, a maximum of 10% of the index size (number of stocks in the index) may be changed in a calendar year. Changes carried out for (2) above are irrespective of changes, if any, carried out for (1) above.

Always Yours — AS Usual — Saurabh Singh

 Source: Money Control Portal

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Food Price Shock May be in Wings

Comments Off on Food Price Shock May be in WingsPosted by on May 24, 2012

 

Consumers awoke this morning to a sharp rise in the price of gasoline. By next month, they may also be facing higher prices for two other everyday items – imported cooking oil and pulses – because of the weakness of the rupee.

India, the world’s largest importer of edible oil, has so far not felt the pinch as a fall in international prices for oil has largely offset the impact of the weakening currency. (A weak rupee means it takes more rupees to buy the oil, which is sold in dollars.)

However, with the rupee expected to slide further, analysts say it is just a matter of time before importers either hold off increasing imports even though the coming months are a time of peak consumption. They could even slow their imports, a move that would further tighten domestic supply. Either way, prices are likely to rise.

The rupee’s weakness “is definitely hitting us as it has increased our cost,” said B.V Mehta, executive director of the Solvent Extractors’ Association of India, a trade body for the edible oil industry. “Everybody will wait for the dust to settle on the rupee before increasing their imports.”

The total cost of cooking oil imports is expected to rise to about 500 billion rupees ($8.9 billion) in the year that began April 1, from 400 billion rupees in the previous 12 months, largely because of the fall in rupee value. Those higher costs are likely to be passed on to consumers.

A flattening or reduction of edible oil imports would be a sharp reversal. In the first six months of the marketing year that began Nov. 1, edible oil imports rose 31% from the same period a year earlier to 4.6 million tons.

Consumers also may be paying more for pulses, the main source of protein for a majority of the population, because of a similar dynamic.

“We have absorbed most the rising import costs so far, but if the rupee’s free fall continues we may have to stop imports or raise the prices,” said Bimal Kothari, vice president of the India Pulses and Grains Association.

The country imports around 3 million tons of the protein staple annually.

Prices of milk and poultry are also expected to rise because of a 50% jump in the cost of feed material.

One possible plus for consumers is that the monsoon rains are expected to be normal and that has brightened the crop prospects for other staples such as rice, oilseeds, sugar and domestically-grown pulses.

“The overall scenario doesn’t look too good in the coming months especially for the imported food items like edible oil and pulses,” said Naveen Mathur, associate director for commodities and currencies at Angel Broking. “The food prices may escalate further. It may go through the roof. [Compiled from DJ Reprints]

Always Yours — As Usual— Saurabh Singh

 

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……..and Markets Came Tumbling Down ……..an attempt to explore the Cause..

Comments Off on ……..and Markets Came Tumbling Down ……..an attempt to explore the Cause..Posted by on May 8, 2012

……..and  Markets Came Tumbling After

Perhaps, both Dr. Manmohan Singh as Leader of Ruling Party in Power and Mr. Pranab Mukherjee, as Finance Minister went up there, this budget session, to specially put the Indian GDP in higher growth trajectory. Probably all went in vein. All accepted; but then what could be the reason at the route of it? Is anyone interested and involved in finding out the route cause or all are merely trying to make the smart, logical and rational guesses.

Many experts have been found blaming it on the variety of issues, and the sum of these issues is much larger number than all the experts giving their opinion put together. It signals an impression that now a doctoral thesis should be presented on ways of identifying that the individual, who is well dressed and has somehow made it to a position of power and claiming to be expert of domain, is really an expert or a garbage vomiting biological machine.

Market Crash of Two Different Centuries     1930 — &–2008

The reasons forwarded by expert for any wanted or unwanted oscillation in the national economy has as much probability of being found in few phrases mentioned below, as much is for any oscillation happening in mood of markets, in next day trading session.

An Attempt:

1. Probably this is an outcome of policy paralysis at the level of Government…

2. It is due to fear being felt by FIIs due to the possible provisions of GAAR on P- Notes…..

3. This is being reflected as the Rupee is getting weaker……

4. It is due stubbornness being shown by RBI Governor by not easing interest rate…

5. It is an outcome of inflationary pressure…..

6. Because European markets opened on lower side…

7. Euro zone crisis is having its impact felt… as all the economies are networked these days….

8. Prices of Crude Oil are moving northwards due to possible stance of USA on Iran’s nuclear issue..

9. The monsoon has cracked a joke on us….

10. The quarter -1 , 2, 3, 4 data for industrial output were not promising….

11. There is a growth being noticed in unemployment rate in USA….

12. Forecast of Chinese economy has taken the fizz out of the market….

13. All this is due to the nation’s money lying in the tax heavens abroad….

14. The growing fiscal deficit is responsible for it….

15. It is the burden of subsidy that is killing the government…..

16. Investors’ are fearful of risky assets and they going for Cash or preferring cash..

17. The Greece crisis has taken its toll….

18. The Spaniards are going uncontrolled……

19. It is due to the Vodafone issue..Where FM wants to put a tax with Retrospective effect..

20. Rupee falters on rupee outflow fear…..

21. Now markets are waiting for first signal of Mr. Hollande, the new President of France.….

…..

 

 

,,,,

 

                                                                                                                   

////

 

 

…..

N. The grocery seller was saying that Fed is in for an interest rate hike…..

N+1. I heard my taxi driver telling to someone that it is being stage managed by the government…

N+2. There is a foul smell of some foreign hands behind it…….

This is not the end of the list, and therefore just an illustrative one has been put up. Please feel free to add your suggestions. The names will be sent to Nobel Committee which supposed to announce the Current Years’ Nobel Prize Winner in Economics by conducting a free and fair lucky draw from it…..

                                                                                                                     Always Yours— As Usual —– Saurabh Singh

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PARTICIPATORY NOTES OR P-NOTES – A CHAOS; CONFUSION; TREACHERY OR SOME THING ELSE?…..A JOURNEY ….

Comments Off on PARTICIPATORY NOTES OR P-NOTES – A CHAOS; CONFUSION; TREACHERY OR SOME THING ELSE?…..A JOURNEY ….Posted by on May 6, 2012

P – NOTES – AN OVERVIEW

Perhaps, since Mr. Pranab Mukherjee, the present Finance Minister of UPA government (2009 – 2014) has presented his finance bill on March 16, 2012, the Term “P – Notes [Participatory Notes]” has transformed or metamorphosed in an instrument of mass massacre at Indian capital markets. Probably in current era we do not have Black Friday but probably a new kind of day, i.e., P – Note day, though the common term “Black Monday” is associated with these P – Notes. Even a rumor on the issue of GAAR and P – Note is good enough to create an epic blood bath in Indian Capital Markets these days.

The class of investors suffering maximum burnt are ‘the new breed of retail investors’, and I feel this to be the worst impact of the event, as this phenomenon may turn the retail investors chary and scary both. Consequently the flow of money to capital markets may decline significantly, rather it may get once again get diverted to safe heavens, i.e., to nationalized bank in India, out of which majority are in cash plus state. This mean the capital that was meant for capital markets will get locked into banks and simultaneously these banks will have to shell out more amount as interest on these deposits; without getting any returns on them (as there are no borrowers available in market, who may love to pick money from bank in the regime of sky rocketing interest rates).

Participatory notes can be found making it to news headlines every alternate day, but due to all bad reasons. They have been in the root of biggest fall witnessed at capital markets in current era. The apex regulatory bodies of Capital Market and Money Market,, i.e., SEBI and RBI are also making it to the headlines of pink paper these days, as they are found issuing notices and warnings to the parties using this instrument.

The financial analysts and experts dealing in or related to Capital Markets are neither concerned nor worried about this instrument, as Indian Investors do not and cannot use this instrument. At the same time they do not have a say in the issue, as it is the government which is supposed decide the fate of Participatory Notes. The P – Notes come into prominence when the deliberations are regarding or related to Foreign Institutional Investors [FIIs].

But what are Participatory Notes [P – Notes]

This as question is circulating in the conscious or sub-conscious part of mind of every individual or retail investor. They are a confused lot due to probably two reasons. First being that till a few months ago they had neither heard about any such instrument nor had they thought that something unknown may throw all their investments plans hay ware. Whereas, the second reason is their failure to comprehend that why it is they, who are paying the cost for something not known, and why the government and market regulators are working towards saving their interests.

An Attempt to Explain what P-Notes Are:

Just like any other derivative ‘Participatory Notes’ too are simply ‘derivative instruments’ that is used by investors not registered in India or Mauritius to trade in Indian markets

Numerous FIIs, which are neither registered nor they wish to get registered with SEBI, but are interested in getting exposure to Indian Securities, place their orders through brokerage houses that have Mauritius-based FII accounts.

These ‘P-Notes’ are generated as a consequence of the action of brokers who buy or sell securities on behalf of their clients on their proprietary account and as a result of the transaction, issue ‘notes’ in favor of such foreign investors. It is these notes which are called in profession of securities trading as “Participatory Notes”. The brokerage houses then repatriate the dividends and capital gains back to these entities, which are generated as a consequence of such trade. In this case, the broker acts like an exchange: it executes the trade and uses its internal accounts to settle the trade. They keep the investor’s name anonymous.

Somehow, anonymous investors are not liked by the regulators of Capital Markets. The recently out, Lahiri Committee Report, also lays emphasis on participatory notes, its role and functioning.

 

Exhibit – 1: Functioning of Participatory Notes

P-Notes, down the line exhibit properties of Hedge Funds. Although SEBI, as a regulator had issued KYC (Know Your Client) guidelines, which include that, FIIs must know all the requisites details about their client and be able to furnish the details of the same, as and when demanded or asked by the regulator, to which there should be strict compliance, failing which the regulator may sentence them to very harsh punishments or even capital punishments, as was done by SEBI in case of UBS Securities. SEBI barred UBS Securities from trading in Indian markets on this premise only as they could not succeed in furnish the information regarding their clients. Though, finally SAT reversed the SEBI’s order.

The Bigger Issue

The bigger question needs to address the debate on hedge funds and why regulators like SEBI and RBI are wary of them….. ? That will be another topic of discussion with some other headline. For the time being the deliberations stop here.

Author

Always Yours — As Usual — Saurabh Singh

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