What is an Index?

In economics and finance, an index is a statistical aggregate that measures change. All indices are not the same. They differ based on countries, the market capital of the stocks they cover, trading frequency, and so on. SENSEX and NIFTY, both are indices. 

What is SENSEX? 

The term SENSEX  was coined by a stock market analyst Mr. Deepak Mohoni. The word is a combination of Sensitive and Index. It reflects the activities of the Bombay Stock Exchange (BSE). BSE was established on 9 July 1875. The BSE is the world’s 10th largest stock exchange with an overall market capitalization of $2.29 Trillion as of April 2018. More than 5500 companies are publicly listed on the BSE.

The SENSEX  comprises 30 prominent stocks which are selected on the basis of financial soundness and performance and are traded actively  Usually, large and well-established companies that are representatives of the various industrial sectors are chosen. As of March 2020, a few of the companies involved are HDFC, Reliance, Infosys, ITC, Asian Paints, Maruti, Titan, HCL, Bajaj Auto, ONGC, L&T, Nestle India, Bharti Airtel, etc. Explaining in simpler terms, 11 of the best cricket players from the entire country are chosen to represent the country. Their performance is seen as the performance of the country.  

Why is it sensitive? This is because it keeps on changing according to the share prices of the companies included. The movement of the SENSEX is either up or down. If SENSEX  goes up it means there is a general increase in the share prices of the shares that hold weightage in the index. If SENSEX goes down then it means there is a decrease in the share prices. Let us say that the SENSEX is 35,400 today. If SENSEX drops to 32,300 three days later, it means that the majority of the 30 companies see a lowering in their share prices. 

Taking a simple example, if SENSEX was just comprised of just a single company whose share price is Rs. 3000. The SENSEX value would then be 3000 points. It increased last year by 300 points. But this year dropped by Rs. 200. If shareowners sold shares and the share price reduced to Rs. 1000, the SENSEX value would have gone down by 2000 points.

In real terms, it involves 30 companies. So even if one player of the team is not playing well or if the prices of one company falls down, the team could still win or the Sensex could still go up. An important point to keep in mind is that SENSEX is just an index point and it has nothing to do with monetary denominations.

How is the SENSEX index value calculated? 

Initially, SENSEX was calculated using the weighted market capitalization methodology. Since September 1, 2003, the Free Float Market Capitalization methodology has been used.

Here are some important terms to remember:

• Market Capitalization - It represents the valuation of the company. It is determined by multiplying the price of a stock with the number of shares issued by that company. 
  Market capitalization = Price x Number of Shares 

• Free Float Factor -  It is the percentage of the total number shares of the company that are available readily for trading in the market excluding the shares that are held by the government, promoters, etc. It is always rounded off to the higher multiple of 5. So if a company has 100 shares out of which 38 are owned by the government and 62 are up for trading. The free float factor becomes 62% or 0.62 which is rounded to 0.65. 

• Free-Float Market Capitalization - It is determined by finding out the product of the market capitalization value and the free float factor.
  Free-Float Market Capitalization =  Market Capitalization x Free Float Factor

Calculation:

• The Market Capitalizations and the Free Float Market Capitalization of all the 30 companies are determined. The Free Float Market Capitalization of all the 30 companies is summed up to get a total figure
• These values are now put in the formula of SENSEX = (Total Free-Float Market Capitalization/ Base Market Capitalization) x Base Index Value.
• The base year to calculate SENSEX is 1978-79, the base value is static. 
• According to BSE Rs. 2501.24 crore is to be used as the Base Market Capitalization.
• The Base Index Value is 100.
• SENSEX = (Free-Float Market Capitalization of 30 selected companies /25041.24 crores) x 100

What is NIFTY?

If you have a clear understanding of SENSEX then understanding NIFTY is quite easy. NIFTY is an index of the National Stock Exchange( NSE). The NSE has more than 1600 companies listed on its platform. The NSE was established in 1992 as the first demutualized electronic exchange in the country and NIFTY also known as NIFTY 50 was introduced on April 12, 1996. NIFTY is an abbreviation of the National Stock Exchange 50. It is owned and managed by India Index Services and Products Ltd. (IISL).

NIFTY as the name suggests comprises 50 well established and financially sound companies listed on the NSE. These stocks span across 12 sectors of the Indian economy which include – IT, financial services, entertainment and media, metals, pharmaceuticals, consumer goods, telecommunications, automobiles, fertilizers, cement and its products, energy, and other services. Just like SENSEX, NIFTY also goes up and down depending on either the increase or decrease in the stock prices of the 50 companies involved. 

How is NIFTY calculated? 

It is also calculated using the Free Float Market Capitalization method.

• The Market Capital is determined by finding out the product of the Equity Capital and the Market Price Per Share.
  Market Capital = Equity Capital x Price 
• The Free Float Market Capitalization is found by multiplying the Price Per Share and the Investable Weight Factor (IWF). IWF is a factor that is used to determine the number of shares available for trading.
• The Free Float Market Capitalization values of all the 50 companies is summed up.
• Index is calculated by NIFTY = (Total Free Float Market Capitalization x Base Index Value)/ Base Market Value
• The Base Year is 1995.
• The Base Index Value is taken as 1000.
• The Base Market Value is taken as Rs. 2.06 trillion.

For example,

NIFTY has two companies X and Y. X has 2000 shares, 1000 held by promoters, and 1000 are free-floating. Y has 3000 shares 1000 held by promoters and 2000 are actively traded.
The per-share price of X is 10 and Y is 20. 
Total Market Capitalization (X) = 2000 x 10 = 20000
Total Market Capitalization (Y) = 3000 x 20 = 60000
Free Float Market Capitalization (X) = 1000 x 10 = 10000
Free Float Market Capitalization (Y) = 2000 x 20 = 40000
Total of Free Float Market Capitalization (X + Y) = 10000 + 40000 = 50000
Let us assume that the Base Market Value is 5000.
NIFTY = 50000 x 1000/ 5000 = 10000

What is the difference between SENSEX and NIFTY?

• SENSEX  was Founded in 1986 whereas NIFTY was founded in 1995.
• SENSEX is the stock market index for BSE Limited while NIFTYis the stock market index for National Stock Exchange (NSE).
• SENSEX consists of 30 stocks while NIFTY of 50 stocks.

The SENSEX and NIFTY are benchmark indices of the Indian share market and can very literally be understood as a ‘sign of the times’.

Quick Fun Fact:

• Dalal Street, in Mumbai, is the address of the Bombay Stock Exchange (BSE) and of several related financial firms and institutions. When the BSE was moved to the intersection of Bombay Samachar Marg and Hammam Street, the street next to it was renamed Dalal Street. In Hindi 'Dalal' means “a broker”. The term “Dalal Street” is used in the same way as “Wall Street” in the U.S.