We hear and read daily in news papers about SENSEX but what is it all about? Read toady’s General awareness topic : SENSEX- A benchmark or barometer of economic development?
SENSEX is the benchmark index of the Indian Capital Markets with wide acceptance among individual investors, institutional investors, foreign investors and fund managers. SENSEX is a free-float market capitalization-weighted stock market index of 30 well-established and financially sound companies listed on Bombay Stock Exchange.
The 30 component companies, which are some of the largest and most actively traded stocks, are representative of various industrial sectors of the Indian economy. If the Index price is increased, it shows the Economic progress of the country. It is used as a barometer of Economic development and vice versa.
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Initially, the index was calculated based on the ‘full market capitalization’ method. Now, it is calculated based on a free float capitalization method. In this method, instead of using a company's total outstanding shares it uses its float, or the shares that are readily available for trading. The free-float method, therefore, does not include restricted stocks, such as those held by promoters, government and strategic investors. Globally, the free float market capitalization is regarded as the industry best practice.
The objectives of the index are:
To measure market movements
Given its long history and its wide acceptance, no other index matches the SENSEX in reflecting market movements and sentiments. SENSEX is widely used to describe the mood in the Indian Stock markets.
Benchmark for funds performance
The inclusion of blue chip companies and the wide and balanced industry representation in the SENSEX makes it the ideal benchmark for fund managers to compare the performance of their funds.
For index based derivative products
Institutional investors, money managers and small investors all refer to the SENSEX for their specific purposes The SENSEX is in effect the proxy for the Indian stock markets. The country's first derivative product i.e. Index-Futures was launched on SENSEX.
Moreover, the criteria for selection and review of scrips for the SENSEX is based on following criteria –
The scrip should figure in the top 100 companies listed by market capitalization. Also market capitalization of each scrip should be more than 0.5 % of the total market capitalization of the Index i.e. the minimum weight should be 0.5 %. Since the SENSEX is a market capitalization weighted index, this is one of the primary criteria for scrip selection. (Market Capitalization would be averaged for last six months)
(i) Trading Frequency: The scrip should have been traded on each and every trading day for the last one year. Exceptions can be made for extreme reasons like scrip suspension etc.
(ii) Number of Trades: Number of Trades: The scrip should be among the top 150 companies listed by average number of trades per day for the last one year.
(iii) Value of Shares Traded: Value of Shares Traded: The scrip should be among the top 150 companies listed by average value of shares traded per day for the last one year.
Whenever the composition of the index is changed, the continuity of historical series of index values is re-established by correlating the value of the revised index to the old index (index before revision). The back calculation over the last one-year period is carried out and correlation of the revised index to the old index should not be less than 0.98. This ensures that the historical continuity of the index is maintained.
Scrip selection would take into account a balanced representation of the listed companies in the universe of BSE. The index companies should be leaders in their industry group.
The scrip should have a listing history of at least one year on BSE.
In the opinion of the Index Committee, the company should have an acceptable track record.
Later, SENSEX Realized Volatility (REALVOL) was introduced which provides market participants with an accurate measure of the historic volatility of the SENSEX over fixed 1, 2, and 3-month time horizons, which are synchronized with BSE’s 1, 2, and 3-month futures & options expiration cycles. Each index is reset at the end of its respective cycle.
The SENSEX Realized Volatility family of indices has several practical uses, like –
(iv)Can be used to create derivative products enabling traders to make directional bets on volatility, profit from volatility arbitrage trades, and hedge gamma exposure
(v)Can be used to measure the difference in expected and actual volatility, allowing traders to better measure and mitigate market risk
(vi)Can be used to improve volatility and correlation forecasts useful for portfolio allocation and risk management
The movement of SENSEX tells whether the prices of shares listed on the stock exchange are going up or down as a whole. Movement of SENSEX is determined by the demand and supply of shares which is determined by the buyers and sellers. The behavior of buyers and sellers in the market basically reflects their opinion on future of the company’s share that they are holding. So they act on what is very popularly known as “market sentiments”.
These market sentiments are nothing but “feelings” of buyers and sellers on whether price of shares will go up or down in the future. These sentiments are created by various news that can have an impact on the fortunes of the company.
Such news can be any news that can affect the performance of the company whose shares are bought and sold. However, while SENSEX is a good indicator of the performance of the economy, it cannot be taken as a barometer of the Indian economy.
Movements in share prices always reflect “market sentiments” of investors. It is what the investors think that is reflected in the share price movements. In a way that is an opinion of the market on the expectations about the future performance of companies listed on the stock exchange.
Movements in share prices can always indicate economic health, but never measure it. Measurement of health of an economy should always be left to key economic indicators and not share price movements that reflect sentiment.
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