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Jan 10, 2011

Bombay Stock Exchange

The material has been taken from www.BSE-India.com and is to be strictly used as supplementary reading material only. Kindly acknowledge the original source (and not this blog) in case you reproduce it.

Introduction

Bombay Stock Exchange is the oldest stock exchange in Asia What is now popularly known as the BSE was established as "The Native Share & Stock Brokers' Association" in 1875.

Over the past 135 years, BSE has facilitated the growth of the Indian corporate sector by providing it with an efficient capital raising platform.

Today, BSE is the world's number 1 exchange in the world in terms of the number of listed companies (over 4900). It is the world's 5th most active in terms of number of transactions handled through its electronic trading system. And it is in the top ten of global exchanges in terms of the market capitalization of its listed companies (as of December 31, 2009, source: WFE 2009 Market Highlights). The companies listed on BSE command a total market capitalization of USD Trillion 1.36 as of 31st March, 2010.

The BSE Index, SENSEX, is India's first and most popular Stock Market benchmark index. Exchange traded funds (ETF) on SENSEX, are listed on BSE and in Hong Kong. Futures and options on the index are also traded at BSE.

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 (Base value=100). 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.

SENSEX 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.

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')

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 capitalization 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 at BSE. 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 capitalization 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 capitalization should be at least 0.5% of the Index.
  5. Industry/Sector 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 BSE Index Committee, the company should have an acceptable track record.

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 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.

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-Ã -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.

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.

The remaining shareholders 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. (Format available on www.bseindia.com). BSE 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

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