Stock market indices

Stock market indices are the parameters of the stock market. With some 5000 companies listed on the Bombay Stock exchange, it is not possible to look at the prices of every stock to find out whether the market movement is is in inclining position or in declining. The Indus give a broad outline of the market movement and represent the market. some of the stock market indices are BSE sensex, BSE 200, Dollex, NSE 50, CRISIL 500, Business line 250 and RBI indices of ordinary shares.

Needs of indices

1. In this help to recognise the broad trends in the market.

2. Index can be used as a benchmark for evaluating the investors portfolio.

3. Indices function as a status report on the general economy. Impacts of the various economic policies are reflected on the stock market.

4. The investor can use the indices to allocate funds rationally among stocks. To on returns on par with the market returns, you can choose the stocks that reflect the market movement efficiently.

5. Index funds and futures are formulated with the help of the indices. Usually fund managers construct portfolio to emulate any one of the major stock market index.

6. Technical analyst studies the historical performance of these indices and predict the future movement of the stock market. And this is how it helps investor to invest in stock market. The relationship between the individual stock and index predicts the individual share price movement.

Computation of stock index

Stock market index may either be a price index or wealth index. The untreated price index is a simple arithmetic average of share prices with the base date. This index gives an idea about the general price movement of the constituents that reflects the entire market. In a wealth index the prices are weighted by market capitalisation. In such an index, the base period values are adjusted for subsequent rights and bonus offers. This gives an idea about the real wealth created for shareholders over a period of time. The given example gives the calculation procedure for the wealth index:

Let's take an example of a index constructed with three scripts X, Y and Z. Equity of the company X: 100 (par value ₹10)

     Equity of the company Y:200  (par value ₹10)

     Equity of the company Z:250 (par value ₹10)

     Market price of scrip X: ₹20

     Market price of scrip Y: ₹30

     Market price of scrip Z: ₹40

 Market capitalisation (MC) = Number of shares × Prices of shares

  X = 100× ₹20 = ₹2000

  Y = 200× ₹30 = ₹ 6000

  Z = 250× ₹40 = ₹10000

Aggregate market capitalisation = ₹18000

  Index at period N = 100

  Market price at N+1

                           X share price = ₹25

                           Y share price = ₹40

                           Z share price = ₹50

Market capitalisation

            X = 100 × ₹25 = ₹2500

            Y = 200 × ₹40 = ₹8000

            Z = 250 × ₹50 = ₹ 12500

Aggregate Market Capitalisation = ₹23000

       Index at period N+1 = ₹23000 × 100/18000

                                  N+1 = 127.78

 

   The weight may be the trading volume of the particular scrip. When the index uses the trading volume as weight, on it shows the depth of the market in terms of trading volumes and conditions. All India equity index of Financial express with base year 1979 uses the trading volume of the script as weight. 

The business line - (BL) - 250 (Base January 17, 1994 = 100) a comprehensive index comprising of 43 industry group is a wealth index and the weight used if the market capitalisation. If the index is broad based it can indicate the market movement in a comprehensive manner. The influence of individual scrip is smaller in a broad based index. In the case of the unweighted price index selected scrips, price average is calculated in relation to a base year. The Sadi price just above the price movement. The Ordinary Share Price Index of The Economic Times with basic 1984-85 is of this type.

Reference: Security Analysis and Portfolio Management by Punithavathy Pandian