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Confused by the Sensex? Here’s help

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Everyone has heard of the Sensex. Most of us know it is the index of the Bombay Stock Exchange. But there are lots of facts you are probably unware of. Here are six interesting facts about the Sensex.

1. The Sensex is an abbreviated version of The Bombay Stock Exchange Sensitive Index.

It is the benchmark index for the Indian stock market, closely followed by Nifty, which is the index of the National Stock Exchange. Officially called S&P CNX Nifty, this name is credited to the 50 stocks that comprise its index.

2. The Sensex is made up of only 30 stocks.

These stocks represent around a dozen sectors. They are leaders in their respective industries. To see the 30 companies, read The stocks that make up the Sensex.

3. The stocks are picked by the stock selection committee (known as the Index Committee).

There are certain basic parameters fixed when picking these 30 stocks. They are:

~ 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.

~ 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.

~ The stock should have been listed on the BSE for at least one year.

4. The job of the Sensex is to capture the price movement of the equity market.

The Sensex reflects the price movements of shares. If the Sensex rises, it indicates the market is doing well.

The price of every stock price rises or falls for two possible reasons:

News about the company
Great earnings, great annual or quarterly results, 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.

News about the country
Testing a nuclear bomb, a terrorist attack, the Budget announcement, new tax regime, declaration of war, change of government, good monsoons and hence a good agricultural crop, 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. It could also reflect the sentiment of the market as a whole. If corporate India is largely doing well, then it will get reflected here.

A good index will only capture news that is common to all stocks in India. This is what the Sensex does. In order to present a broad picture, the stocks selected are from different sectors.

5. The value of each of the stocks in the Sensex is not equal.

The market cap method

Each of the 30 stocks in the Sensex has a weight attached to it. This weight depends on the market capitalisation of the stock.

Market capitalisation refers to the number of shares of a company multiplied by its market value (the price of each share). For instance, if a company has 10 million shares whose value is Rs 30 per share on July 1, 2006, it will have a market cap of Rs 300 million on July 1, 2004.

Let’s assume the market cap of the 30 Sensex stocks is Rs 3,00,000 crore. Let us also assume the market cap of ITC (which is one of the 30 shares that make up the Sensex) is Rs 20,000 crore, then ITC’s weight in the Sensex is 6.66%.

The rise or fall in the price of ITC’s shares will impact the Sensex to that extent.

This is referred to as the full market capitalisation methodology.

Free-float weightage

Here, a company’s entire lot of shares are not taken into account (which means we are not looking at the entire market capitalisation). Only the shares readily available for trading are considered.

In every company, a certain amount of shares are not available for trading on the stock exchange. These shares could be held by the government or the promoters of the company. Under the free-float weightage method, they are not taken into account.

How does the stock exchange arrive at this weightage?

In this case, the market cap is multiplied by the free float factor (which is the proportion of a company’s shares that can be readily bought and sold).

The Sensex uses the free-float weightage method.

The Sensex’s free-float market cap at close of business on December 3, 2005, was Rs 3,66,124 crore.

Unlike the Sensex, the 50 stocks in Nifty — the index of the National Stock Exchange — is based on the market cap method and not the free-float method.

You can read about the free-float method in detail on the BSE web site.

6. The clincher

Even though the BSE came into existence in 1875, the Sensex was formulated and came into existence only in 1986.

Written by Bhushan Kulkarni

January 24, 2007 at 11:39 am

Posted in Stocks

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