SENSEX

THE BAROMETER OF INDIAN CAPITAL MARKETS

Introduction

For the premier Stock Exchange that pioneered the stock broking activity in India, 128 years of
experience seems to be a proud milestone. A lot has changed since 1875 when 318 persons
became members of what today is called "The Stock Exchange, Mumbai" by paying a princely
amount of Re1.

Since then, the country's capital markets have passed through both good and bad periods. The
journey in the 20th century has not been an easy one. Till the decade of eighties, there was no
scale to measure the ups and downs in the Indian stock market. The Stock Exchange, Mumbai
(BSE) in 1986 came out with a stock index that subsequently became the barometer of the Indian
stock market.

SENSEX is not only scientifically designed but also based on globally accepted construction and
review methodology. First compiled in 1986, SENSEX is a basket of 30 constituent stocks
representing a sample of large, liquid and representative companies. The base year of SENSEX
is 1978-79 and the base value is 100. The index is widely reported in both domestic and
international markets through print as well as electronic media.

The Index was initially calculated based on the "Full Market Capitalization" methodology but was
shifted to the free-float methodology with effect from September 1, 2003. The "Free-float Market
Capitalization" methodology of index construction is regarded as an industry best practice
globally. All major index providers like MSCI, FTSE, STOXX, S&P and Dow Jones use the Free-
float methodology.

Due to is wide acceptance amongst the Indian investors; SENSEX is regarded to be the pulse of
the Indian stock market. 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 over the years
become one of the most prominent brands in the country.

The growth of equity markets in India has been phenomenal in the decade gone by. Right from
early nineties the stock market witnessed heightened activity in terms of various bull and bear
runs. The SENSEX captured all these events in the most judicial manner. One can identify the
booms and busts of the Indian stock market through SENSEX.

SENSEX Calculation Methodology

SENSEX is calculated using the "Free-float Market Capitalization" methodology. As per this
methodology, 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 every 15
seconds and disseminated in real time.

Dollex-30

BSE also calculates a dollar-linked version of SENSEX and historical values of this index are
available since its inception. (For more details click ‘Dollex series of BSE indices’)

Understanding Free-float Methodology

Concept:

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 Index. 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. 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.

In India, BSE pioneered the concept of Free-float by launching BSE TECk in July 2001 and
BANKEX in June 2003. While BSE TECk Index is a TMT benchmark, BANKEX is positioned as a
benchmark for the banking sector stocks. SENSEX becomes the third index in India to be based
on the globally accepted Free-float Methodology.

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. For example, the concentration of top five
companies in SENSEX has fallen under the free-float scenario thereby making the
SENSEX more diversified and broad-based.

 A Free-float index aids both active and passive investing styles. It aids active managers
by enabling them to benchmark their fund returns vis-à-vis an investable 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.

Definition of Free-float:

Share holdings held by 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. In
specific, the following categories of holding are generally excluded from the definition of Free-
float:

 Holdings by founders/directors/ acquirers which has control element

 Holdings by persons/ bodies with "Controlling Interest"
 Government holding 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.

The remaining shareholders would fall under the Free-float category.

Determining Free-float factors of companies:

BSE has designed a Free-float format, which is filled and submitted by all index companies on a
quarterly basis with the Exchange. (Format available on www.bseindia.com) The Exchange
determines the Free-float factor for each company based on the detailed information submitted by
the companies in the prescribed format. Free-float factor is a multiple with which the total market
capitalization of a company is adjusted to arrive at the Free-float market capitalization. Once the
Free-float of a company is determined, it is rounded-off to the higher multiple of 5 and each
company is categorized into one of the 20 bands given below. A Free-float factor of say 0.55
means that only 55% of the market capitalization of the company will be considered for index
calculation.

Free-float Bands:

% Free-Float Free-Float Factor % Free-Float Free-Float Factor

>0 – 5% 0.05 >50 – 55% 0.55

>5 – 10% 0.10 >55 – 60% 0.60

 >10 – 15% 0.15 >60 – 65% 0.65

>15 – 20% 0.20 >65 – 70% 0.70

>20 – 25% 0.25 >70 – 75% 0.75

>25 – 30% 0.30 >75 – 80% 0.80

>30 – 35% 0.35 >80 – 85% 0.85

>35 – 40% 0.40 >85 – 90% 0.90

>40 – 45% 0.45 >90 – 95% 0.95

>45 – 50% 0.50 >95 – 100% 1.00

Index Closure Algorithm

The closing SENSEX on any trading day is computed taking the weighted average of all the
trades on SENSEX constituents in the last 30 minutes of trading session. If a SENSEX
constituent has not traded in the last 30 minutes, the last traded price is taken for computation of
the Index closure. If a SENSEX constituent has not traded at all in a day, then its last day's
closing price is taken for computation of Index closure. The use of Index Closure Algorithm
prevents any intentional manipulation of the closing index value.

Maintenance of SENSEX

One of the important aspects of maintaining continuity with the past is to update the base year
average. The base year value adjustment ensures that replacement of stocks in Index, additional
issue of capital and other corporate announcements like 'rights issue' etc. do not destroy the
historical value of the index. The beauty of maintenance lies in the fact that adjustments for
corporate actions in the Index should not per se affect the index values.

The Index Cell of the exchange does the day-to-day maintenance of the index within the broad
index policy framework set by the Index Committee. The Index Cell ensures that SENSEX and all
the other BSE indices maintain their benchmark properties by striking a delicate balance between
frequent replacements in index and maintaining its historical continuity. The Index Committee of
the Exchange comprises of experts on capital markets from all major market segments. They
include Academicians, Fund-managers from leading Mutual Funds, Finance-Journalists, Market
Participants, Independent Governing Board members, and Exchange administration.

On-Line Computation of the Index:

During market hours, prices of the index scrips, at which trades are executed, are automatically
used by the trading computer to calculate the SENSEX every 15 seconds and continuously
updated on all trading workstations connected to the BSE trading computer in real time.

Adjustment for Bonus, Rights and Newly issued Capital:

The arithmetic calculation involved in calculating SENSEX is simple, but problem arises when
one of the component stocks pays a bonus or issues rights shares. If no adjustments were made,
a discontinuity would arise between the current value of the index and its previous value despite
the non-occurrence of any economic activity of substance. At the Index Cell of the Exchange, the
base value is adjusted, which is used to alter market capitalization of the component stocks to
arrive at the SENSEX value.

The Index Cell of the Exchange keeps a close watch on the events that might affect the index on
a regular basis and carries out daily maintenance of all the 14 Indices.

 Adjustments for Rights Issues:

When a company, included in the compilation of the index, issues right shares, the free-
float market capitalisation of that company is increased by the number of additional
shares issued based on the theoretical (ex-right) price. An offsetting or proportionate
adjustment is then made to the Base Market Capitalisation (see 'Base Market
Capitalisation Adjustment' below).

 Adjustments for Bonus Issue:

When a company, included in the compilation of the index, issues bonus shares, the
market capitalisation of that company does not undergo any change. Therefore, there is
no change in the Base Market Capitalisation, only the 'number of shares' in the formula is
updated.

 Other Issues:
Base Market Capitalisation Adjustment is required when new shares are issued by way of
conversion of debentures, mergers, spin-offs etc. or when equity is reduced by way of
buy-back of shares, corporate restructuring etc.

 Base Market Capitalisation Adjustment:

The formula for adjusting the Base Market Capitalisation is as follows:

New Market Capitalisation

New Base Market Old Base Market ------------------------------------
= x
Capitalisation Capitalisation ---
Old Market Capitalisation

To illustrate, suppose a company issues right shares which increases the market
capitalisation of the shares of that company by say, Rs.100 crores. The existing Base
Market Capitalisation (Old Base Market Capitalisation), say, is Rs.2450 crores and the
aggregate market capitalisation of all the shares included in the index before the right
issue is made is, say Rs.4781 crores. The "New Base Market Capitalisation " will then be:

2450 x (4781+100)
-------------------------- = Rs.2501.24 crores
4781

This figure of 2501.24 will be used as the Base Market Capitalisation for calculating the
index number from then onwards till the next base change becomes necessary.

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SENSEX - Scrip selection criteria:

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

1. Listed History:The scrip should have a listing history of at least 3 months at BSE.
Exception may be considered if full market capitalisation of a newly listed company ranks
among top 10 in the list of BSE universe. In case, a company is listed on account of
merger/ demerger/ amalgamation, minimum listing history would not be required.

2. Trading Frequency:The scrip should have been traded on each and every trading day in
the last three months. Exceptions can be made for extreme reasons like scrip suspension
etc.
3. Final Rank:The scrip should figure in the top 100 companies listed by final rank. The
final rank is arrived at by assigning 75% weightage to the rank on the basis of three-
month average full market capitalisation and 25% weightage to the liquidity rank based
on three-month average daily turnover & three-month average impact cost.
4. Market Capitalization Weightage:The weightage of each scrip in SENSEX based on
three-month average free-float market capitalisation should be at least 0.5% of the Index.
5. Industry Representation:Scrip selection would generally take into account a balanced
representation of the listed companies in the universe of BSE.
6. Track Record:In the opinion of the Committee, the company should have an acceptable
track record.

Index Review Frequency:

The Index Committee meets every quarter to discuss index related issues. In case of a revision in
the Index constituents, the announcement of the incoming and outgoing scrips is made six weeks
in advance of the actual implementation of the revision of the Index.

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History of replacement of scrips in SENSEX

Date Outgoing Scrips Replaced by

01.01.1986 Bombay Burmah Voltas

Asian Cables Peico

Crompton Greaves Premier Auto.

Scinda G.E.Shipping

03.08.1992 Zenith Ltd. Bharat Forge

19.08.1996 Ballarpur Inds. Arvind Mills

 Bharat Forge Bajaj Auto

Bombay Dyeing BHEL

Ceat Tyres BSES

Century Text. Colgate

GSFC Guj. Amb. Cement

Hind. Motors HPCL

Indian Organic ICICI

Indian Rayon IDBI

Kirloskar Cummins IPCL

Mukand Iron MTNL

Phlips Ranbaxy Lab.

Premier Auto State Bank of India

Siemens Steel Authority of India

Voltas Tata Chem

16.11.1998 Arvind Mills Castrol

G. E. Shipping Infosys Technologies

IPCL NIIT Ltd.

Steel Authority of India Novartis

10.04.2000 I.D.B.I Dr. Reddy’s Laboratories

Indian Hotels Reliance Petroleum

Tata Chem Satyam Computers

 Tata Power Zee Telefilms

08.01.2001 Novartis Cipla Ltd.

07.01.2002 NIIT Ltd. HCL Technologies

Mahindra & Mahindra Hero Honda Motors Ltd.

31.05.2002 ICICI Ltd. ICICI Bank Ltd.

10.10.2002 Reliance Petroleum Ltd. HDFC Ltd.

10.11.2003 Castrol India Ltd. Bharti-Tele-Ventures Ltd.

Colgate Palomive (India) Ltd. HDFC Bank Ltd.

Glaxo Smithkline Pharma. Ltd. ONGC Ltd.

HCL Technologies Ltd. Tata Power Company Ltd.

Nestle (India) Ltd. Wipro Ltd.

19.05.2004 Larsen & Toubro Ltd. Maruti Udyog Ltd.

27.09.2004 Mahanagar Telephone Nigam Ltd. Larsen & Toubro Ltd.

06.06.2005 Hindustan Petroleum Corp Ltd. National Thermal Power Corpn. Ltd.

Zee Telefilms Ltd. Tata Consultancy Services Ltd.

12.06.2006 Tata Power Ltd. Reliance Communiation Ventures Ltd.

Back
 remember Freddie Mercury of Queen belting out these lyrics, "Don't stop me now, I'm having a
good time, I'm having a ball"? Well, that seems the Sensex's song at the moment.

The Sensex, which has crossed the 6,000 mark, seems unstoppable.

Which makes it the right time to give you some dope on the hot new craze in town.

What's so hot about the Sensex?

It is the benchmark index for the Indian stock market. It is the most frequently used indictor while
reporting on the state of the market.

The index has just one job: To capture the price movement. So a stock index will reflect the price
movements of shares while a bond index captures the manner in which bond prices go up or
down.

If the Sensex rises, it indicates the market is doing well. Since stocks are supposed to reflect
what companies expect to earn in the future, a rising index indicates investors expect better
earnings from companies.

It is, therefore, also a measure of the state of the Indian economy. If Indian companies are
expected to do well, obviously the economy should do well too.

In case you are wondering why a stock market index has a provocative term like Sensex, let me
tell you it stands for something quite mundane -- The Bombay Stock Exchange Sensitive Index.

What is the Sensex made of?

Thirty stocks. That's right. Just 30 stocks tell you how the market is faring.

Before you throw up your hands in protest, there is something you should know about these 30
stocks.
For one, they are the most actively traded stocks in the market. In fact, they account for half the
BSE's market capitalisation (To understand the term market capitalisation, read What's in a
share? Money!).

Besides, they represent 13 sectors of the economy and are leaders in their respective industries.
Now that sounds fair, doesn't it?

Who selects these 30 stocks?

They are selected by the Index Committee.

This committee consists of all sorts of individuals including academicians, mutual fund managers,
finance journalists, independent governing board members and other participants in the financial
markets.

How do they select these 30 stocks?

Well, they definitely don't do it on the basis of their individual whims and fancies. Some of the
criteria they follow include:

~ 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 must have been listed on the BSE for at least one year.

Does the Sensex have any contemporaries?

In terms of age? No.

The Sensex is the oldest index in the country. It was born in 1986.

In terms of popularity, the Nifty follows close.

The Nifty? What's that?

Well, the National Stock Exchange has an index called the Nifty (officially called S&P CNX Nifty).
This name can be credited to the 50 stocks that comprise its index.

Isn't that a broader representation than the Sensex?

You're right. The Nifty has 50 stocks covering 24 sectors, as against 30 stocks and 13 sectors for
the Sensex.

In case you are shaking your head about 50 also being too small a number, let me remind you
these 50 stocks account for around 60 percent of the market capitalisation.

If these indices tell us about the market, why do people talk about sectoral indices?
The price of every stock price increases or decreases for two possible reasons:

~ News about the company, like a 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, like testing a nuclear bomb, a terrorist attack, a budget announcement,
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.

A good index will only capture news that is common to all stocks in India. This is what the Sensex
and the Nifty do.

What about stock specific news then?

This is where the sector-specific indices come into the picture. They reflect the performance of
the stocks in a particular sector only

For example, the BSE's IT Index captures the price movements of information technology stocks
while its Bankex represents the change in the prices of bank stocks.

So a look at the specific sector index will tell you about that particular sector. For instance, bank
stocks may not be performing and that will be reflected in the Bankex falling or remaining
stagnant even though the Sensex might have gone up.

Did you know the NSE has a mid-cap index that is made up of mid-sized companies?

This index has run up smartly in recent months, rising even more than the Nifty, which shows that
people have been investing more in smaller companies. This could be because the price for the
stocks of bigger companies has increased recently.

Now, let's see how globally savvy you are.

Guess the countries these indices represent -- Dow Jones Industrial Average, the FTSE (Footsie)
and the Nikkei?

The US, the UK and Japan.

Next: How Sensex movements are calculated

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