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Introduction to Index
Each Index has its own calculation methodology and usually is expressed in terms of a change from a base value. The base value might be as recent as the previous day or many years in the past.
Financial indices are created to measure price movement of stocks, bonds, T-bills and other type of financial securities. More specifically, a stock index is created to provide market participants with the information regarding average share price movement in the market. Broad indices are expected to capture the overall behaviour of equity market and need to represent the return obtained by typical portfolios in the country.
Significance of Index
TYPES OF STOCK MARKET INDICES
Market Capitalization Weighted Index
Market capitalization is the market value of a company, calculated by multiplying the total number of shares outstanding to its current market price.
For example, ABC company with 5,00,00,000 shares outstanding and a share price of Rs 120 per share will have market capitalization of 5,00,00,000 x 120 = Rs 6,00,00,00,000 i.e. 600 Crores.
Free-float Market Capitalization Index
Equal Weighted Index
Attributes of an Index
It should reflect the market behaviour
It should be computed by independent third party and be free from influence of any market participant
It should be professionally maintained
What is Impact Cost
Features of Impact Cost
It is separately computed for buy and sell
It may vary for different transaction sizes
It is dynamic and depends on the outstanding orders
where a stock is not sufficiently liquid, a penal impact cost is applied
Index construction is all about choosing the index stocks and deciding on the index calculation methodology. Maintenance means adjusting the index for corporate actions like bonus issue, rights issue, stock split, consolidation, mergers etc.
Revision of index deals with change in the composition of index as such i.e. replacing some existing stocks by the new ones because of change in the trading paradigm of the stocks / interest of market participants.
Index Maintenance and Index Revision
Major Indices in India
S&P BSE Sensex
S&P BSE Midcap
S&P BSE 100
S&P BSE 200
S&P BSE 500
Nifty Next 50
Application of Indices
Traditionally, indices were used as a measure to understand the overall direction of stock market. However, few applications on index have emerged in the investment field. Few of the applications are explained below
Exchange Traded Funds