How Sensex Works

How Sensex Works?
(Article from Economic Times of India)
The Sensex is regarded as the pulse of the domestic stock markets. Investors
follow this index closely and use it as a barometer to base their investment
decisions on. The Sensex is based on globally accepted construction and review
methodology. It was first compiled in 1986. It is a basket of 30 constituent stocks
representing a sample of large, liquid and representative companies. The base
year of the Sensex is 1978-79 and the base value is 100.
The index is widely reported in both domestic and international markets. The
Sensex is the oldest stock market index in the country. It provides the time series
data over a fairly long period of time. The Sensex is calculated using the 'free float
market capitalization' method. According to this method, the level of index at any
point of time reflects the free-float market value of 30 component stocks relative
to a base period.
Initially, the index was calculated based on the 'full market capitalization' method.
However, this was shifted to the free-float method with effect from September 1,
2003. Globally, the free-float market capitalization method of index construction
is regarded as an industry best practice. All major index providers like S&P, Dow
Jones, MSCI, STOXX, and FTSE use the free-float method.
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 calculation of the Sensex involves dividing the free-float market capitalization
of 30 companies in the index by a number called the index divisor. The divisor
keeps the index comparable over time and is the adjustment point for all index
adjustments arising out of corporate actions, replacement of scrip’s etc.
During market hours, prices of the index scrips, at which latest trades are
executed, are used by the trading system to calculate the Sensex every 15
seconds and disseminate in real time.
The closing figure is computed taking the weighted average of all the trades on
the Sensex constituents in the last 15 minutes of the trading session. If a Sensex
constituent has not traded in the last 15 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 the index closure.
When a company, included in the compilation of the index, issues right shares,
the free-float market capitalization of that company is increased by the number of
additional shares issued based on the theoretical (exright) price. An offsetting or
proportionate adjustment is then made to the base market capitalization. When a
company, included in the compilation of the index, issues bonus shares, the
market capitalization of that company does not undergo any change. Therefore,
there is no change in the base market capitalization, only the 'number of shares'
in the formula is updated.
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.
In order to maintain continuity with the past, the base year average needs to be
updated. The base year value adjustment ensures that replacement of stocks in
the index, additional issue of capital and other corporate announcements like
rights issue etc. do not destroy the historical value of the index. The adjustments
for corporate actions in the index should not per se affect the index values.
The base market capitalization 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 buyback of shares, corporate restructuring etc.
Example:
Suppose the Index consists of only 2 stocks: Stock A and Stock B.
Suppose company A has 1,000 shares in total, of which 200 are held by the
promoters, so that only 800 shares are available for trading to the general public.
These 800 shares are the so-called 'free-floating' shares.
Similarly, company B has 2,000 shares in total, of which 1,000 are held by the
promoters and the rest 1,000 are free-floating.
Now suppose the current market price of stock A is Rs 120. Thus, the 'total'
market capitalisation of company A is Rs 120,000 (1,000 x 120), but its free-float
market capitalisation is Rs 96,000 (800 x 120).
Similarly, suppose the current market price of stock B is Rs 200. The total market
capitalisation of company B will thus be Rs 400,000 (2,000 x 200), but its free-float
market cap is only Rs 200,000 (1,000 x 200).
So as of today the market capitalisation of the index (i.e. stocks A and B) is Rs

520,000 (Rs 120,000 + Rs 400,000); while the free-float market capitalisation of
the index is Rs 296,000. (Rs 96,000 + Rs 200,000).
The year 1978-79 is considered the base year of the index with a value set to 100.
What this means is that suppose at that time the market capitalisation of the
stocks that comprised the index then was, say, 60,000 (remember at that time
there may have been some other stocks in the index, not A and B, but that does
not matter), then we assume that an index market cap of 60,000 is equal to an
index-value of 100.
Thus the value of the index today is = 296,000 x 100/60,000 = 493.33
This is how the Sensex is calculated.
The factor 100/60000 is called index divisor.

How Sensex Works

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How Sensex Works?

(Article from Economic Times of India)

The market capitalization of a company is determined by multiplying the price of

Suppose the Index consists of only 2 stocks: Stock A and Stock B.

So as of today the market capitalisation of the index (i.e. stocks A and B) is Rs

Thus the value of the index today is = 296,000 x 100/60,000 = 493.33

This is how the Sensex is calculated.

The factor 100/60000 is called index divisor.

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