chapter 2 stock market: an overview -...
TRANSCRIPT
17
CHAPTER 2 STOCK MARKET AN OVERVIEW
21 INTRODUCTIONhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip18
22 HISTORY OF WORLD STOCK MARKEThelliphelliphelliphelliphelliphelliphelliphellip18
23 THE ROLE OF STOCK EXCHANGEShelliphelliphelliphelliphelliphelliphelliphelliphelliphellip22
24 MAJOR STOCK EXCHANGEShelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip27
25 REQUIREMENTS BY STOCK EXCHANGEhelliphelliphelliphelliphelliphelliphellip29
26 OWNERSHIPhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip30
27 HISTORY OF INDIAN STOCK MARKEThelliphelliphelliphelliphelliphelliphelliphellip30
28 THE BOMBAY STOCK EXCHANGEhelliphelliphelliphelliphelliphelliphelliphelliphelliphellip38
29 STOCK MARKET INDEXhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip45
210 STOCK MARKET VOLATILITYhelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphelliphellip54
18
21 INTRODUCTION
Stock exchange is a mutual organization which provides trading facilities for stock
brokers and traders to trade stocks and other securities In common mens language
Stock markets refer to a market place where investors can buy and sell stocks The
price at which each buying and selling transaction takes place is determined by the
market forces (ie demand and supply for a particular stock)
Stock exchanges also provide facilities for the issue and redemption of securities as
well as other financial instruments and capital events including the payment of
income and dividends The securities traded on a stock exchange
include shares issued by companies unit trusts derivatives pooled investment
products and bonds To trade a security on a certain stock exchange it has to
be listed there Usually there is a central location at least for recordkeeping but trade
is less and less linked to such a physical place as modern markets are equipped with
electronic networks which gives them advantages of speed and cost efficiency of
transactions Only members are entitling to Trade on an exchange The initial offering
of stocks and bonds to investors is by definition done in the primary market and
subsequent trading is done in the secondary market A stock exchange is often the
most important component of a stock market Supply and demand in stock markets is
driven by various factors which as in all free markets affect the price of stocks
Usually there is no compulsion to issue stock via the stock exchange itself nor must
stock be subsequently traded on the exchange Such trading is said to be off
exchange or over-the-counter This is the usual way that derivatives and bonds are
traded Increasingly stock exchanges are part of a global market for securities
22 HISTORY OF WORLD STOCK MARKET
221 The First Stock Exchanges
It is believed that the first stock was established in 11th century France where
the courtiers de change were concerned with managing and regulating the debts of
Agricultural communities on behalf of the Banks Some stories suggest that the
origins of the term bourse come from the Latin bursa meaning a bag because in
19
13th century Bruges the sign of a purse (or perhaps three purses) hung on the front of
the house where merchants met
There were people in Pisa Verona Genoa and Florence who also began trading in
government securities during the 14th century This was only possible because these
were independent city states ruled by a council of influential citizens not by a duke
The Dutch later started joint stock companies which let shareholders invest in
business ventures and get a share of their profitsmdashor losses In 1602 the Dutch East
India Company issued the first shares on the Amsterdam Stock Exchange It was the
first company to issue stock and bonds In 1688 the trading of stocks began on a
stock exchange in London
On May 17 1792 twenty-four supply brokers signed the Buttonwood Agreement
outside 68 Wall Street in New York underneath a buttonwood tree On March 8
1817 properties got renamed to New York Stock amp Exchange Board In the 19th
century exchanges got substantiated to trade futures contracts and then choices
contracts generally famous as futures exchanges
222 London Stock Exchange - 1698
London Stock Exchange is arguably the oldest of the worlds major stock exchanges
The London Exchange can trace its history back to 1698 when its founder - John
Casting - began to organize the market in Jonathans Coffee-house via a simple list of
stock and commodity prices Today this exchange lists 3500 companies representing
84 countries
223 New York Stock Exchange - 1792
The New York Stock Exchange or NYSE is arguably the oldest and most well known
of all the American stock markets The NYSE was formed in 1792 when two dozen
stockbrokers from New York City had the idea to organize what was then a
disorganized and chaotic method of stock trading From those humble beginnings the
NYSE has continued to grow and today lists 2800 companies with a total
capitalization of nearly $20 trillion In 2007 a historic merger of equals created the
NYSE Euro next
20
224 Bombay Stock Exchange ndash 1875
The Bombay Exchange also known as Mumbai claims to be the oldest stock
exchange in Asia tracing its history back to 1875 In 2008 nearly 2000000 shares
of stock traded daily on the Bombay Exchange
225 American Stock Exchange - 1849
The American Stock Exchange or Amex is a relatively recent addition to the worlds
stock markets The history of this stock market begins with the Curb Exchange and
the California Gold Rush of 1849 The Amex played an important part in the
financial and business transactions associated with the mining industry in the 19th
century In 1921 the Amex expanded it niche role to include companies that did not
meet the strict standards of the NYSE In 1998 the NASDAQ purchased Amex and it
continues its history of being a niche market player and today specializes in
derivatives and stock options In late 2003 the American Stock Exchange regained
its independence After only six years under the control of NASDAQ The Amex
Membership Corporation completed an agreement to transfer control of the exchange
back to its membership
226 NASDAQ - 1971
Yes weve even included a relatively recent addition in this article on stock market
history And thats because we recognize the importance of this particular exchange
At one time most companies aspired to be traded on the NYSE That changed about
10 years ago and many large companies now trade on the NASDAQ Founded in
1971 the National Association of Securities Dealers Automated Quotation or
NASDAQ was the first stock exchange to recognize the role of electronics in stock
trading
Today stock exchanges operate around the world and they have become highly
regulated institutions Investors wanting to buy and sell shares must do so through a
share broker who pays to own a seat on the exchange Companies with shares traded
on an exchange are said to be listed and they must meet specific criteria which
varies across exchanges Most stock exchanges began as floor exchanges where
21
traders made deals face-to-face The largest stock exchange in the world the New
York Stock Exchange continues to operate this way but most of the worlds
exchanges have now become fully electronic The graphs below show (Chart 21 amp
22) world markets in both 1900 and 2000 and the anomalous growth of
the US market during this time While having 10 market share in 1900 India is
leading stock market but in 2000 market share of India is reduced drastically
Chart 21 Stock Market In 1900
Chart 22 Stock Market In 2000
Source Triumph of the optimists
22
12
254
2
11
10
43
7USA
UK
EUROLAND
JAPAN
SOUTH AFRICA
RASSIA
INDIA
AUSTRIA HUNGARY
LATIN AMERICA
47
8
13
13
211
6USA
UK
EUROLAND
JAPAN
CANADA
OTHER FORM 1900
NEW MARKET
22
23 THE ROLE OF STOCK EXCHANGES
The role of a stock exchange for any country appears to be vitally important For any
countries moving toward economic assimilation of enlistment and proficient
allocation of savings to productive investments stock market play imperative role
This is largely proficient through a sound financial architecture Quite a lot of the
most flourishing evolution economies have achieved stupendous increases in the
savings rate with lends a hand of stock exchanges Stock exchanges are indispensable
to support savings and investment in successful conversion countries Companies
often face Liquidation problems that the banking system is powerless or reluctant to
address With a functioning stock market it becomes easier for these firms to find
sources of capital in both domestic and international capital markets A properly
functioning stock exchange will not only help companies raise capital but also help
individuals and organizations to diversify their holdings With thinly traded markets
liquidity problems discourage participation by these investors in the financial system
As such investors will demand higher risk premiums to compensate for lack of
liquidity Thus the company in need of capital is placed at a disadvantage because
only relatively more expensive credit is available Solving this problem has helped
companies to raise more capital in the most successful transition economies while
failure to do so has constrained growth in some of the more backward states Role of
stock exchanges include the following29
231 Raising capital for businesses
The stock market is one of the most important sources for companies to raise money
This allows businesses to be publicly traded or raise additional capital for expansion
by selling shares of ownership of the company in a public market They encourage
investment by providing places for buyers and sellers to trade securities This
investment in turn enables corporations to obtain funds to expand their businesses30
29 Diamond Peter A (1967) The Role of a Stock Market in a General Equilibrium Model with
Technological Uncertainty American Economic Review 57 (4) 759ndash776
30 Gilson Ronald J Black Bernard S (1998) Venture Capital and the Structure of Capital Markets
Banks Versus Stock Markets Journal of Financial Economics 47 243ndash277
23
Corporations issue new securities in the primary market usually with the help of
investment bankers Company negotiates price and then makes the securities available
for its clients and other investors This is called an initial public offering (IPO)
In this primary market corporations receive the proceeds of stock sales After this
initial offering the securities are bought and sold in the secondary market The
corporation is not usually involved in the trading of its stock in the secondary market
therefore stock exchanges will essentially function as a secondary market By
providing investors the opportunity to trade financial instruments the stock exchanges
support the performance of the primary markets This arrangement makes it easier for
a corporation to raise the funds that they need to build and expand their businesses
Although corporations do not directly benefit from secondary market transactions the
managers of a corporation closely monitor the price of the corporationlsquos stock in
secondary markets Reasons for this concern involves the cost of raising new funds
for further business expansion the perceived strength of a company (and whether it
is vulnerable to a takeover) and of course their options and bonus packages
There are benefits and new obligations that come from raising capital through a public
offering
Benefits
Companylsquos access to capital will increase since you can contact more
potential investors
Company may become more widely known
Company may obtain financing more easily in the future if investor interest in
your company grows enough to sustain a secondary trading market in your
securities
Controlling shareholders such as the companys officers or directors may
have a ready market for their shares which means that they can more easily
sell their interests at retirement for diversification or for some other reason
24
Company may be able to attract and retain more highly qualified personnel if
it can offer stock options bonuses or other incentives with a known market
value
The image of company may be improved
Obligations
Company must continue to keep shareholders informed about the companys
business operations financial condition and management incurring additional
costs and new legal obligations
Company may be liable if you do not fulfill these new legal obligations
Company may lose some flexibility in managing your companys affairs
particularly when shareholders must approve your actions
Company public offering will take time and money to accomplish
232 Mobilizing savings for investment
When people draw their savings and invest in shares it leads to a
more rational allocation of resources because funds which could have been
consumed or kept in idle deposits banks are mobilized and redirected to
promote business activity with benefits for several economic sectors such
as agriculture commerce and industry resulting in stronger economic growth and
higher productivity levels of firms
233 Facilitating company growth
The smooth functioning of all these activities facilitates economic growth in that
lower costs and enterprise risks promote the production of goods and services as well
as employment In this way the financial system contributes to increased prosperity
An important aspect of modern financial markets however including the stock
markets is absolute discretion For example American stock markets see more
unrestrained acceptance of any firm than in smaller markets attention must be given to
25
the foreign Companies view acquisitions as an opportunity to expand product lines
increase distribution channels hedge against volatility increase its market share or
acquire other necessary business assets A takeover bid or a merger agreement
through the stock market is one of the simplest and most common ways for a
company to grow by acquisition or fusion
234 Profit sharing
Both casual and professional stock investors through dividends and stock
price increases that may result in capital gains will share in the wealth of profitable
businesses
235 Corporate governance
By having a wide and varied scope of owners companies generally tend to improve
on their management standards and efficiency in order to satisfy the demands of these
shareholders and the more stringent rules for public corporations imposed by public
stock exchanges and the government Consequently it is alleged that public
companies (companies that are owned by shareholders who are members of the
general public and trade shares on public exchanges) tend to have better management
records than privately-held companies (those companies where shares are not publicly
traded often owned by the company founders andor their families and heirs or
otherwise by a small group of investors) However some well-documented cases are
known where it is alleged that there has been considerable slippage in corporate
governance on the part of some public companies The dot-com bubbles in the early
2000s and the subprime mortgage crisis in 2007-08 are classical examples of
corporate mismanagement Companies like Petscom (2000) Enron
Corporation (2001) OneTel (2001) Sunbeam(2001) Webyan (2001) Adelphia
(2002) MCI World Com (2002) Parmalat (2003) American International Group
(2008) Lehman Brothers (2008) and Satyam Computer Service(2009) were among
the most widely scrutinized by the media
26
236 Creating investment opportunities for small investors
As opposed to other businesses that require huge capital outlay investing in shares is
open to both the large and small stock investors because a person buys the number of
shares they can afford Therefore the Stock Exchange provides the opportunity for
small investors to own shares of the same companies as large investors
The liquidity that an exchange provides affords investors the ability to quickly and
easily sell securities This is an attractive feature of investing in stocks compared to
other less liquid investments such as real estate
237 Government capital-raising for development projects
Governments at various levels may decide to borrow money in order to finance
infrastructure projects such as sewage and water treatment works or housing estates
by selling another category of securities known as bonds These bonds can be raised
through the Stock Exchange whereby members of the public buy them thus loaning
money to the government The issuance of such bonds can obviate the need to directly
tax the citizens in order to finance development although by securing such bonds
with the full faith and credit of the government instead of with collateral the result is
that the government must tax the citizens or otherwise raise additional funds to make
any regular coupon payments and refund the principal when the bonds mature
238 Barometer of the economy
Form the history of many countries it has shown that the price of share and other
assets is an important part of the dynamics of economic activity The price of these
assets can influence or be an up and coming economy Many times the stock market is
considered the primary indicator of a countrylsquos economic development and strength
If the stock market is rising it tends to be associated with increased business and
investments and if the stock market if falling associated with deceased business and
investments It can also be observed that share prices also affect the wealth of
households and their consumption At the stock exchange share price rise or fall may
depending largely on market forces and sentiments When the economy is stable or
growing the share prices tense to raise or remain stable but when economic face
recession depression or financial crisis result in stock market crash Therefore the
27
movement of share prices and in general of the stock indexes can be an indicator of
the general trend in the economy
24 MAJOR STOCK EXCHANGES
Twenty Major Stock Exchanges Of The World Market Capitalization amp Year-to-date
Total Turnover at the end of August 2009
Table 21 Major Stock Exchanges of World
(August 2009 Figure in Million USD) Region Stock Exchange Market Value
Total Share
Turnovers
America Satildeo Paulo Stock Exchange 103251840 36195900
America Toronto Stock Exchange 143287700 79819310
America New York Stock Exchange 1084200190 1215862060
Asia-Pacific Australian Securities Exchange 106651320 56091280
Asia-Pacific Bombay Stock Exchange 108257200 17117620
Asia-Pacific Hong Kong Stock Exchange 194551770 97022760
Asia-Pacific Korea Exchange 72712530 105047380
Asia-Pacific National Stock Exchange of India 101910900 50665230
Asia-Pacific Shanghai Stock Exchange 214275680 331576850
Asia-Pacific Shenzhen Stock Exchange 59632020 170125680
Asia-Pacific Tokyo Stock Exchange 347860250 267598330
Europe Euro next 260509760 119596220
Europe Frankfurt Stock Exchange (Deutsche Boumlrse) 120429200 158973670
Europe London Stock Exchange 256049110 232151850
Europe Madrid Stock Exchange (Bolsas y Mercados
Espantildeoles)
117852560 104075110
Europe Milan Stock Exchange (Borsa Italiana) 63667480 56575930
Europe Nordic Stock Exchange Group OMX1 78114630 50304990
Europe Swiss Exchange 99235640 52086750
Note includes the Copenhagen Helsinki Iceland Stockholm Tallinn Riga and
Vilnius Stock Exchanges
Sources World Federation of Exchanges - Statistics Monthly
Remarks There are 2 pending major mergers NASDAQ with OMX and London
Stock Exchange with Milan Stock Exchange
28
Chart 23 Market Value
Chart 24 Total Share Turnovers
Source From the table 21
000 400000000 800000000 1200000000
Satildeo Paulo Stock Exchange
Toronto Stock ExchangeNew York Stock Exchange
Australian Securities ExchangeBombay Stock Exchange
Hong Kong Stock ExchangeKorea Exchange
National Stock Exchange of India
Shanghai Stock ExchangeShenzhen Stock Exchange
Tokyo Stock ExchangeEuro next
Frankfurt Stock Exchange (Deutsche Boumlrse)
London Stock ExchangeMadrid Stock Exchange (Bolsas y hellip
Milan Stock Exchange (Borsa Italiana)Nordic Stock Exchange Group OMX1
Swiss Exchange Market hellip
000 500000000 1000000000 1500000000
Satildeo Paulo Stock ExchangeToronto Stock Exchange
New York Stock ExchangeAustralian Securities Exchange
Bombay Stock ExchangeHong Kong Stock Exchange
Korea ExchangeNational Stock Exchange of India
Shanghai Stock ExchangeShenzhen Stock Exchange
Tokyo Stock ExchangeEuro next
Frankfurt Stock Exchange (Deutsche hellipLondon Stock Exchange
Madrid Stock Exchange (Bolsas y hellipMilan Stock Exchange (Borsa Italiana)Nordic Stock Exchange Group OMX1
Swiss Exchange Total Share hellip
29
25 REQUIREMENTS BY STOCK EXCHANGE
Companies have to meet the requirements of the exchange in order to have their
stocks and shares listed and traded there but requirements vary by stock exchanges
251 Bombay Stock Exchange
Bombay Stock Exchange (BSE) has requirements for a minimum market
capitalization of Rs250 Million and minimum public float equivalent to Rs100
Million31
252 London Stock Exchange
The main market of the London Stock Exchange has requirements for a minimum
market capitalization (pound700000) three years of audited financial statements
minimum public float (25 per cent) and sufficient working capital for at least 12
months from the date of listing
253 NASDAQ Stock Exchange
To be listed on the NASDAQ a company must have issued at least 125 million shares
of stock worth at least $70 million and must have earned more than $11 million over
the last three years 32
254 New York Stock Exchange
To be listed on the New York Stock Exchange (NYSE) a company must have issued
at least a million shares of stock worth $100 million and must have earned more than
$10 million over the last three years 33
255 Other types of exchanges
In the 19th century exchanges were opened to trade forward
contracts on commodities Exchange traded forward contracts are called futures
contracts These commodity exchanges later started offering future contracts on other
31 wwwbseindiacomaboutabintrobselistsecasp 32 NASDAQ Corporate -NASDAQ Listing Information wwnasdaqcomaboutlisting_informationstm 33 wwwnysecomFramesethtmldisplayPage=listed
30
products such as interest rates and shares as well as Options contracts They are now
generally known as futures exchanges
26 OWNERSHIP
Stock exchanges originated as mutual organizations owned by its member stock
brokers There has been a recent trend for stock exchanges to demutualize where the
members sell their shares in an initial public offering In this way the mutual
organization becomes a corporation with shares that are listed on a stock exchange
Examples are
Australian Securities Exchange (1998) Euro next (merged with New York Stock
Exchange) NASDAQ (2002) The New York Stock Exchange (2005) Bolsas
Mercados Espanoles and the Sao Paulo Stock Exchange (2007) The Shenzhen and
Shanghai stock exchanges can be characterized as quasi-state institutions insofar as
they were created by government bodies in China and their leading personnel are
directly appointed by the China Securities Regulatory Commission
27 HISTORY OF INDIAN STOCK MARKET
The stock exchange in Mumbai is more than 100 years old The origin of the stock
market in India dates back to the end of the eighteenth century when long term
negotiable securities were first issued The real beginning however occurred in the
middle of the nine teeth century after the enactment of the Companies Act in 1850
which introduced the feature of limited liability and generated investor interest in
corporate securities
The Native Share and Stock Brokerslsquo Association now known as the Bombay Stock
Exchange (BSE) was formed in Bombay (now Mumbai) in 1875 This was followed
by the formation of association in Ahmadabad in 1894 Calcutta (now Kolkata) in
1908 and Madras (now Chennai) in 1937 In order to promote the orderly
development of the stock market the central government introduced a comprehensive
legislation called the Securities Contracts (Regulation) Act 1956
31
The Calcutta Stock Exchange (CSE) was the largest stock exchange in India till the
1960s In 1961 there were 1203 listed companies across the various stock exchanges
of the country Of these 576 were listed on the CSE and 297 on the BSE However
during the later half of the 1960s the relative importance of the CSE declined while
that of the BSE increased sharply
One of the oldest stock markets in Asia the Indian Stock Markets have a 200 years
old history
Table 22 Origin of Indian Stock Market
Year Events
18th
Century
East India Company was the dominant institution and by end of the century business in its loan
securities gained full momentum
1830s Business on corporate stocks and shares in Bank and Cotton presses started in Bombay Trading list
by the end of 1839 got broader
1840s Recognition from banks and merchants to about half a dozen brokers
1850s Rapid development of commercial enterprise saw brokerage business attracting more people into
the business
1860s The number of brokers increased to 60
1860-61 The American Civil War broke out which caused a stoppage of cotton supply from United States of
America marking the beginning of the Share Mania in India
1862-63 The number of brokers increased to about 200 to 250
1865 A disastrous slump began at the end of the American Civil War (as an example Bank of Bombay
Share which had touched Rs 2850 could only be sold at Rs 87)
1874 With the rapidly developing share trading business brokers used to gather at a street (now well
known as Dalal Street) for the purpose of transacting business
1875 The Native Share and Stock Brokers Association (also known as The Bombay Stock
Exchange) was established in Bombay
1880s Development of cotton mills industry and set up of many others
1894 Establishment of The Ahmadabad Share and Stock Brokers Association
1880 -
90s
Sharp increase in share prices of jute industries in 1870s was followed by a boom in tea stocks and
coal
1908 The Calcutta Stock Exchange Association was formed
1920 Madras witnessed boom and business at The Madras Stock Exchange was transacted with 100
brokers
1923 When recession followed number of brokers came down to 3 and the Exchange was closed down
32
1934 Establishment of the Lahore Stock Exchange
1936 Merger of the Lahore Stock Exchange with the Punjab Stock Exchange
1937 Re-organization and set up of the Madras Stock Exchange Limited (Pvt) Limited led by
improvement in stock market activities in South India with establishment of new textile mills and
plantation companies
1940 Uttar Pradesh Stock Exchange Limited and Nagpur Stock Exchange Limited was established
1944 Establishment of The Hyderabad Stock Exchange Limited
1947 Delhi Stock and Share Brokers Association Limited and The Delhi Stocks and Shares Exchange
Limited were established and later on merged into The Delhi Stock Exchange Association
Limited
Sources wwwsurfindiacom wwwappuonlinecom
271 Post Independence Scenario
The depression witnessed after the Independence led to closure of a lot of exchanges
in the country Lahore Stock Exchange was closed down after the partition of India
and later on merged with the Delhi Stock Exchange Bangalore Stock Exchange
Limited was registered in 1957 and got recognition only by 1963 Most of the other
Exchanges were in a miserable state till 1957 when they applied for recognition under
Securities Contracts (Regulations) Act 1956 The Exchanges that were recognized
under the Act were
Bombay Calcutta Madras Ahmadabad Delhi Hyderabad Bangalore Indore
272 Many more stock exchanges were established during 1980s
namely
Cochin Stock Exchange (1980)
Uttar Pradesh Stock Exchange Association Limited (at Kanpur 1982)
Pune Stock Exchange Limited (1982)
Ludhiana Stock Exchange Association Limited (1983)
Gauhati Stock Exchange Limited (1984)
Kanara Stock Exchange Limited (at Mangalore 1985)
33
Magadh Stock Exchange Association (at Patna 1986)
Jaipur Stock Exchange Limited (1989)
Bhubaneswar Stock Exchange Association Limited (1989)
Saurashtra Kutch Stock Exchange Limited (at Rajkot 1989)
Vadodara Stock Exchange Limited (at Baroda 1990)
Coimbatore Stock Exchange
Meerut Stock Exchange
At present there are twenty one recognized stock exchanges in India which does not
include the Over The Counter Exchange of India Limited (OTCEI) and the National
Stock Exchange of India Limited (NSEIL)
Government policies during 1980s also played a vital role in the development of the
Indian Stock Markets There was a sharp increase in number of Exchanges listed
companies as well as their capital which is visible from the following table
Table 23 Pattern of Growth of Stock Exchanges
Source SEBI annual report
273 Trading Pattern of the Indian Stock Market
Indian Stock Exchanges allow trading of securities of only those public limited
companies that are listed on the Exchange(s) They are divided into two categories
S
No
As on 31st December 1946 1961 1971 1980 1991 1995 2000 2005
1 No of Stock Exchanges 7 7 8 9 20 22 23 23
2 No of Listed Cos 1125 1203 1599 2265 6229 8593 9413 4731
5 Market value of Capital
of Listed Cos (Cr Rs)
971 1292 2675 6750 110279 478121 6319212 478121
34
Chart 25 Trading Pattern of the Indian Stock Market
Source wwwbseindiacom
274 Types of Transactions
The flowchart below describes the types of transactions that can be carried out on the
Indian stock exchanges
Chart 26 Types of Transactions
Source wwwbseindiacom
Listed Securities of Public limited companies
Specified securities (forward List)
Equity shares of company that are
- Dividend paying
- growth orinted companies
- paid up capital of atleast Rs50 million
- Market capitalisation of atleast Rs100 million
- has more than 20000 shareholders
Non specicied Securities (Cash List)
equity shares of companies not covered in specified securities
Transactions on Indian Stock Exchanges
Spot Delivery Transactions
Forward Transactions
35
Spot Delivery Transactions
Includes transactions that require delivery and payment within stipulated time
period at the time of entering into the contract
This period shall not be more than 14 days following the date of the contract
Forward Transactions
Transactions in which delivery and payment can be extended by further period
of 14 days each
The overall period should not exceed 90 days from the date of contract
Transactions permitted only in case of specified shares
275 Indian stock exchange allows a member broker to perform
following activities
Act as an agent
Buy and sell securities for clients and charge commission for the same
Act as a trader or dealer as a principal
Buy and sell securities on their account and risk
276 Over The Counter Exchange of India (OTCEI)
Traditionally trading in Stock Exchanges in India followed a conventional style
where people used to gather at the Exchange and bids and offers were made by open
outcry This age-old trading mechanism in the Indian stock markets used to create
much functional inefficiency Lack of liquidity and transparency long settlement
periods and benami transactions are a few examples that adversely affected investors
In order to overcome these inefficiencies OTCEI was incorporated in 1990 under the
Companies Act 1956 OTCEI is the first screen based nationwide stock exchange in
India created by Unit Trust of India Industrial Credit and Investment Corporation of
India Industrial Development Bank of India SBI Capital Markets Industrial Finance
Corporation of India General Insurance Corporation and its subsidiaries and Can
Bank Financial Services
36
Chart 27 Securities traded on the OTCEI
Source wwwbseindiacom
Listed Securities
Securities of the companies listed on the OTC
Can be bought or sold at any OTC counter across India
Should not be listed anywhere else
Permitted Securities
Certain securities (Shares and debentures listed on other exchanges)
Unites of Mutual funds can be traded
Initiated Debentures
An equity holding a minimum of one lakh debentures of a particular scrip can
offer them for trading on the OTC
Advantages of OTCEI
Greater liquidity and lesser risk of intermediary charges due to widely spread trading
mechanism across India The screen-based scrip less trading ensures transparency and
accuracy of prices Faster settlement and transfer process as compared to other
exchanges Shorter allotment procedure (in case of a new issue) than other exchanges
277 National Stock Exchange
In order to lift the Indian stock market trading system at par with the international
standards On the basis of the recommendations of high powered Pherwani
Securities teaded on the
OTCEI
Listed Securities
Permitted Securities
Initiated Debentures
37
Committee the National Stock Exchange was incorporated in 1992 by Industrial
Development Bank of India Industrial Credit and Investment Corporation of India
Industrial Finance Corporation of India all Insurance Corporations selected
commercial banks and others
2771 NSE provides exposure to investors in two types of markets
namely
Wholesale debt market
Capital market
Wholesale Debt Market - Similar to money market operations debt market
operations involve institutional investors and corporate bodies entering into
transactions of high value in financial instruments like treasury bills government
securities commercial papers etc
Capital market- A capital market is a market for securities (debt or equity) where
business enterprises and governments can raise long term funds It is defined as a
market in which money is defined as a market in which money is provided for periods
longer than a year34 as the raising of short term funds takes place on other markets
Capital markets may be classified as primary markets and secondary markets In
primary markets new stock or bond issues are sold to investors via a mechanism
known as underwriting In the secondary markets existing securities are sold and
bought among investors or traders usually on a securities exchange over the counter
or elsewhere
278 Trading at NSE amp BSE
Fully automated screen-based trading mechanism
Strictly follows the principle of an order-driven market
Trading members are linked through a communication network
34 Steven M Sheffrin (2003) Economics Principles in action Upper Saddle River Pearson Prentice
Hall
38
This network allows them to execute trade from their offices
The prices at which the buyer and seller are willing to transact will appear on
the screen
When the prices match the transaction will be completed
A confirmation slip will be printed at the office of the trading member
2781 Advantages of trading at NSE amp BSE
Integrated network for trading in stock market of India
Fully automated screen based system that provides higher degree of
transparency
Investors can transact from any part of the country at uniform prices
Greater functional efficiency supported by totally computerized network
28 THE BOMBAY STOCK EXCHANGE
Formerly the Stock Exchange Mumbai popularly called Bombay Stock Exchange
or BSE is the oldest stock exchange in Asia and has the greatest number of listed
companies in the world with 4700 listed as of August 2007 35
It is located at Dalal Street Mumbai India On 31 December 2007 the equity market
capitalization of the BSE was US $ 179 trillion making it the largest stock exchange
in South Asia and the 12th largest in the world
With over 4700 Indian companies list on the stock exchange [10]
and it has a
significant trading volume The BSE SENSEX (SENSITIVE INDEX) also called the
―BSE 30 is a widely used market index in India and Asia Though many other
exchanges exist BSE and the National Stock Exchange of India account for most of
the trading in shares in India
35 World Federation of Exchanges (2007) wwwworld-exchangesorg
39
281 History of the Bombay Stock exchange
Trading in securities has been in vogue in India for a little over 200 years Trading in
securities dates back 1793 most of them being transactions in loan securities of the
East India Company The broking community prospered as there was a rise in prices
which led to a share mania during 1861-65 This bubble burst in 1865 when the
American Civil War ended The brokers realized that investor confidence in the
securities market could be sustained only by organizing themselves into a regulated
body with defined rules and regulations The realization resulted in formation of ―The
Native Share and Stock Brokerslsquo Association which later came to be known as the
Bombay Stock Exchange In 1875 these brokers assembled at a place now called
Dalal Street
The Bombay Stock Exchange is a voluntary nonprofit making association of broker
members It emerged as a premier stock exchange after the 1960 The increased pace
of industrialization caused by the two world wars protection to the domestic industry
and the governmentlsquos fiscal policies aided the growth of new issues which in turn
helped the BSE to prosper The BSE dominated the Indian Capital Market by
accounting for more than 60 per cent of the all Indian turn over
Until 1992 the BSE operated like a closed club of selected members With the
securities scam outburst in 1992 and the SEBI taking over the rains of the Stock
Market the BSE had to bring about changes in its operational policies Until March
1995 the BSE had an open outcry system of trading However when faced with stiff
competition from NSE the countrylsquos first modern computerized and professionally
managed stock exchange set up in 1994 the BSE had to change its system of trading
and operation
On 14 March 1995 the BSE turned to electronic trading whereby brokers trade using
computers This system is known as the BSE On-line Trading System (BOLT)
The introduction of BOLT helped in improving trading volumes significantly
reducing the spread between buy and sell orders better trading in odd lot shares fixed
income instruments and dealings in the renunciation of rights shares
40
In 1995 BOLT was limited to Mumbai whereas the NSE was operating at the
national level As a result the BSE submitted a proposal for allowing installation of
terminals connected to BOLT in centers outside Mumbai After rejecting the proposal
four times on 29 october 1996 the SEBI finally allowed the BSE to use its BOLT
system nationwide Later the BSE set up a central depository system to dematerialize
shares and promote demate Account (trading)
282 Hours of Operation
Beginning of the Day Session 800 to 900
Trading Session 900 to 1530
Position Transfer Session 1530 to 1550
Closing Session 1550 to 1605
Option Exercise Session 1605 to 1635
Margin Session 1635 to 1650
Query Session 1650 to1735
End of Day Session 1735
The hours of operation for the BSE quoted above are stated in terms of the local time
(ie GMT+530) in Mumbai India
BSElsquos normal trading sessions are on all days of the week except Saturdays Sundays
and Holidays declared by the Exchange in advance 36
283 Services of BSE
BSE also had a wide range of services to empower investors and facilitate smooth
transactions These services are as follows
2831 Investor Services
The Dept of investor services redresses grievances of investors BSE was the first
exchange in the country to provide an amount of Rs 1 million towards the investor
36 Asia Technical Analysis with Phil Smith wwwreutersindianet
41
protection fund it is an amount higher than that of any exchange in the country BSE
launched a nationwide investor awareness program ―Safe Investing in the Stock
Market under which 264 programmers were held in more than 200 cities
2832 The BSE Online Trading (BOLT)
BSE on line Trading (BOLT) facilities on-line screen based trading in securities
BOLT is currently operating in 25000 trader work stations located across over 399
cities in India
2833 BSEWEBXcom
In February 2001 BSE introduced the worldlsquos first centralized exchange based
Internet trading system BSEWEBXcom This initiative enables investors anywhere
in the world to trade on BSE platform
2834 Surveillance
BSElsquos Online Surveillance System (BOSS) monitors on a real time basis the price
movements volume position and real time measurements of the default risk market
reconstruct and generation of cross market alerts
2835 BSE Training Institute
BTI imparts capital market training and certification in collaboration with reputed
management institutes and universities It offers over 40 courses on various aspects of
the capital mark and financial sector More than 20000 people have attended the BTI
program
284 Awards
Fowling awards were given to BSE
The world council of Corporate Governance has awarded the Golden Peacock
Global CSR Award for BSElsquos initiatives in corporate social responsibility
The Annual Reports and Accounts of BSE for the year ended March 312006 and
42
March 312007 have been awarded the ICAI awards for excellence in financial
reporting
The Human Resource Management at BSE has won the Asia-Pacific HRM awards
for its efforts in employer branding through talent management at work health
management at work and excellence in HR through technology
Drawing from its rich past and its equally robust performance in the recent times
BSE will continue to remain an icon in the Indian Capital Market
285 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 days closing price is taken for computation of Index closure
The use of Index Closure Algorithm prevents any intentional manipulation of the
closing index value
286 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 affect the
index values The BSE Index Cell does the day-to-day maintenance of the index
within the broad index policy framework set by the BSE Index Committee The BSE
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 BSE Index Committee comprises
of capital market expert fund managers market participants and members of the BSE
Governing Board
43
287 On-Line Computation of the Index
During trading hours value of the Index is calculated and disseminated on real time
basis This is done automatically on the basis of prices at which trades in Index
constituents are executed
288 Adjustment for Bonus Rights and Newly Issued Capital
SENSEX calculation needs to be adjusted for issue of Bonus or 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 BSE Index Cell the base value is adjusted which is used to alter
market capitalization of the component stocks to arrive at the SENSEX value The
BSE Index Cell keeps a close watch on the events that might affect the index on a
regular basis and carries out daily maintenance of all the 19 Indices
2881 Adjustments for Rights Issues
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 (ex-right) price An offsetting or
proportionate adjustment is then made to the Base Market capitalization
2882 Adjustments for Bonus Issue
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
2883 Other Issues 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
buy-back of shares corporate restructuring etc
44
289 Listing Categories
Before badla was resumed in 1996 there were only two categories of securities listed
on the BSE the specified group of shares comprising The securities in which carry
forward deals were allowed and the cash group shares in which no carry forward deals
were permitted Later it was observed that the facility of carry forward was not being
used in all the 94 scrips in the specified group Hence after badla was resumed the
size of the specified group was reduced to 32 scrips on 3 April 1996 The BSE later
decided to regroup the existing A and B group shares into three categories The BSE
delisted 637 companies for a period of 3 years during 2004-05 for non-compliance of
listing agreements
A Group This group consists of large stock with turnover and high floating stock
with large market capitalization In other words scrips with more liquidity and high
networth are included in this group At present there are 150 scrips in this group
B1 Group This group includes scrips of quality companies with equity above Rs 3
crore with high growth potential and trading frequency No carry forward facility was
allowed in this group in June 2000 there were 1803 scrips in this group
B2 Group Scrips in this group were just like those of B1 but with fortnightly
settlement However in September 1996 the BSE introduced weekly settlement for all
scrips listed on the exchange thus doing away with the distinction between the B1 and
B2 groups On June 2000 there were 3219 scrips in this group
Z Group Subsequently a Z group was introduced in 1999 with scrips of companies
that do not meet the rules regulations and stipulations laid down by the exchange It
is a buyer beware company These are some 300 scrips in the group All Z category
stocks result in delivers
F Group A new Flsquo group pertaining to debt market segment was started with effect
from 9 September 1996
S Group The BSE reduced post-public issue capital base requirement from Rs10
crore to Rs3 crore to attract listing by companies with a smaller capital base It also
45
started a new trading segment small cap stock segment known as the Slsquo segment
Corporate with minimum turnover of an equal amount would be eligible to list scrips
on this segment In addition stocks listed on the regional exchanges would also be
able to list on the lsquoSlsquo segment subject to meeting certain criteria
2810 Base Market capitalization Adjustment
The formula for adjusting the Base Market capitalization is as follows
New Base Market Capitalization (NBMC)
New Market capitalization
NBMC = Old Base Market capitalization x mdashmdashmdashmdashmdashmdashmdashmdashmdashmdashmdash
Old Market capitalization
To illustrate suppose a company issues right shares which increases the market
capitalization of the shares of that company by say Rs100 crores The existing Base
Market capitalization (Old Base Market capitalization) say is Rs2450 crores and the
aggregate market capitalization of all the shares included in the index before the right
issue is made is say Rs4781 crore The New Base Market capitalization will then
be
2450x (4781+100)
_____________________ = Rs250124 crores
4781
This figure of Rs 250124 crore will be used as the Base Market capitalization for
calculating the index number from then onwards till the next base change becomes
necessary
Index Review Frequency
The BSE 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
29 STOCK MARKET INDEX
The stock market index is the most important indices of all as it measures overall
market sentiment through a set of stocks that representative of the market The stock
46
market index is a barometer of the market behavior It reflects direction and indicates
day-to-day fluctuations in stock prices The market index reflects expectations about
the behavior of the economy as a whole It is a precursor of economic cycles The
function of a stock index is to provide investors with information regarding the
average share price in the market An ideal index must represent changes in the prices
of the scrips and reflect price movements of typical shares for better market
representation Stock index is a barometer of a nationlsquos economic health as market
prices reflect expectations about the economylsquos performance Stock indices termed as
leading economic as they indicate what is going to happen in the economy in the
future The returns generated in the stock market are based on future expectations A
good market index incorporates a set of scrips which have high market capitalization
and high liquidity Market capitalization is the sum of the market value of all the
stocks included in the index The market value is derived by multiplying the price of
the share outstanding In other words the bid-ask spread is minimum The index on a
day is calculated as the percentage of the aggregate market value of the set of scrips
incorporated in the index on that day to the average market value of the same scrips
during the base period
291 Definition of an Index
A price index is such as the stock market price of the individual securities in the
market It reflects the overall price or return movements of a group of securities
Movements in an index are determined by sample weighting and computational
procedure Sample is normally generated by random selection or try a non random
selection technique designed to incorporate desired characteristics are used to select
sample shares rather than by completely random selection Major criteria for selection
are market activity due representation to various industrial groups and to major stock
exchanges
292 Global Stock Market Indices
2921 The Dow Jones Industrial averagersquos
It is the most widely watched and quoted index because of its long existence The
Dow has 30 constituents and it follows the methodology of price based weighted
47
Changes to stocks included in the Dow are infrequent three stocks were
addeddropped in 1991 four in 1997 and four in 1999 The addition of Microsoft and
Intel in 1999 was the first inclusion of Nasdaq market stocks to the Dow 30
2922 The Nasdaq composite index
The index is the market capitalization weighted of prices for all the stocks listed in the
Nasdaq stock market The Nasdaq composite began on 8 February 1971 with a base
of 100
2923 The Nasdaq 100 index
Nasdaq 100 comprises the largest computer software and telecom stocks by market
capitalization on the Nasdaq For a company to be included in the Nasdaq 100 it must
have a minimum average trading volume of 100000 shares per day and must have
been trading on a major exchange for at least a year or two
2924 The S amp P 500 index
This index comprises 500 biggest publicly traded companies in the US by market
capitalization Most money managers treat the S amp P 500 as a proxy for the US stock
market The S amp P 500 tries to cover all major areas of US economy To be included a
company must be profitable the prospective company must not be closely hold and
must have a large trading volume for its shares
2925 The FTSE 100
The FTSE 100 consists of the largest 100 companies by full market Value listed on
the London Stock Exchange The FTSE 100 is the benchmark index to indicate the
performance of the European market It is a market capitalization weighted index that
also considers the free float weighted of individual stocks before including them in
the index
2926 The MSCI Indices
Include the MSCIEAFE (Europe Australia and Far East) MSCI Europe MSCI
world MSCI (EMF) and MSCI Pacific Basin Indices
48
The MSCI world Index is a free float adjusted market capitalization index that is
designed to measure global developed market equity performance As of April 2002
the MSCI world Index consisted of the MSCI world Index consisted of the following
23 developed market country indices
Australia Austria Belgium Canada Denmark Finland France Germany Greece
Hong Kong Ireland Italy Japan Netherlands New Zealand Norway Singapore
Portugal Spain Sweden Switzerland United Kingdom and the United States of
America
293 Methodology for Calculating The Index
2931 Price Weighted Index
In this method the price of each stock in the index is summed up which is then
equated to an index starting value An arbitrary date is set as the base and the
Laspeyerlsquos Price Index which measures price changes against a fixed base period
quantity weight is used In case of a stock split the market price of the stock falls and
these results in less weighted in the index The Dow Jones Industrial Average and
Nikkie 225 are price-weighted indices
2932 Equal Weighting
In this method each stocklsquos percentage weight in the index is equal and hence all
stocks have an equal influence on the index movement The value line index at
Kansas City Board of Trade (KCBT) is an equal weighted index
2933 Market Capitalization Weighted
29331 Full Market Capitalization Method
In this method the number of shares outstanding multiplied by the market price of a
companylsquos share determines the scriplsquos weighted in the index The shares with the
highest market capitalization would have a higher weighted and would be most
influential in this type of index Eg S amp P 500 Index in USA and S amp P CNX Nify in
India
49
29332 Modified Capitalization Weighted
This method seeks to limit the influence of the largest stocks in the index which
otherwise would dominate the entire index This method sets a limit on the largest
stock or a group of stocks The NASDAQ 100 Index is calculated by using this
method
294 Free Float Market Capitalization Method
2941 Concept
Free float methodology refers to an index construction methodology that takes in to
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 Strategic holding government 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
All BSE indices with exception of BSE-PSU index have adopted the free-float
methodology
2942 Definition of Free Float
Share holding of investor that would not in the normal course come into the
open market for trading are treated as ―Controlling Strategic Holding and
hence not included in free float specifically the following categories of
holding are generally excluded from the definition of free float
Shares hold by foundersdirectorsacquires which has control element
Shares held by person with ―Controlling Interestlsquo
Shares held by Govt as promoters
50
Holding through the FDI Route
Strategic Stakes by private corporate bodiesindividuals
Equity held by employee welfare trusts
Locked-in-shares and shares which not be sold in the open market in normal
course
2943 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-agrave-Vis an investible
index This enables an apple-to-apple comparison thereby facilitating better
evaluation of performance of active managers
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 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
The free float methodology of index construction is considered to be an industry best
practice and all major index providers like MSCI FTSE SampP 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
51
29441 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 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 055 means that only 55 of the market
capitalization of the company will be considered for index calculation
Table 24 Free-float Bands
Free-Float Free-Float Factor Free-Float Free-Float Factor
gt0 - 5 005 gt50 - 55 055
gt5 - 10 010 gt55 - 60 060
gt10 - 15 015 gt60 - 65 065
gt15 - 20 020 gt65 - 70 070
gt20 - 25 025 gt70 - 75 075
gt25 - 30 030 gt75 - 80 080
gt30 - 35 035 gt80 - 85 085
gt35 - 40 040 gt85 - 90 090
gt40 - 45 045 gt90 - 95 095
gt45 - 50 050 gt95 - 100 100
Source wwwbseindiacom
295 BSE Indices
For the premier stock exchange that pioneered the securities transaction business
in India over a century of experience is a proud achievement A lot has changed since
1875 when 318 persons by paying a then princely amount of Re 1 became members
of what today is called Bombay Stock Exchange Limited (BSE) Over the decades
the stock market in the country has passed through good and bad periods The journey
52
in the 20th century has not been an easy one Till the decade of eighties there was no
measure or scale that could precisely measure the various ups and downs in the Indian
stock market BSE in 1986 came out with a Stock Index-SENSEX- that subsequently
became the barometer of the Indian stock market
The launch of SENSEX in 1986 was later followed up in January 1989 by
introduction of BSE National Index (Base 1983-84 = 100) It comprised 100 stocks
listed at five major stock exchanges in India - Mumbai Calcutta Delhi Ahmadabad
and Madras The BSE National Index was renamed BSE-100 Index from October 14
1996 and since then it is being calculated taking into consideration only the prices of
stocks listed at BSE BSE launched the dollar-linked version of BSE-100 index on
May 22 2006
With a view to provide a better representation of the increasing number of listed
companies larger market capitalization and the new industry sectors BSE launched
on 27th May 1994 two new index series viz the BSE-200 and the DOLLEX-200
Since then BSE has come a long way in attuning itself to the varied needs of
investors and market participants In order to fulfill the need for still broader
segment-specific and sector-specific indices BSE has continuously been increasing
the range of its indices BSE-500 Index and 5 sectorial indices were launched in 1999
In 2001 BSE launched BSE-PSU Index DOLLEX-30 and the countrys first free-
float based index - the BSE TEC Index Over the years BSE shifted all its indices to
the free-float methodology
BSE disseminates information on the Price-Earnings Ratio the Price to Book Value
Ratio and the Dividend Yield Percentage on day-to-day basis of all its major indices
The values of all BSE indices are updated on real time basis during market hours and
displayed through the BOLT system BSE website and news wire agencies
All BSE Indices are reviewed periodically by the BSE Index Committee This
Committee which comprises eminent independent finance professionals frames the
broad policy guidelines for the development and maintenance of all BSE indices The
BSE Index Cell carries out the day-to-day maintenance of all indices and conducts
research on development of new indices
53
2951 BSE-100 Index
A broad-based index the BSE-100 was formerly known as the BSE National index
This Index has 1983-84 as the base year and was launched in 1989 In line with the
shift of the BSE Indices to the globally accepted Free-Float methodology BSE-100
was shifted to Free-Float methodology effective from April 5 2004 The method of
computation of Free-Float index and determination of free-float factors is similar to
the methodology for SENSEX
Table 25 Index Specification
Base Year 1983-84
Base Index Value 100
Date of Launch 3-Jan-89
Method of calculation Launched on full market capitalization
method and effective April 05 2004
calculation method shifted to free-float
market capitalization
Number of scrips 100
Index calculation frequency Real Time
Source wwwbseindiacom
2952 Base Year
The financial year 1983-84 has been chosen as the base year The price stability
during that year and proximity to the index series were the main consideration for
choice of 1983-84 as the base year The base value was fixed at 100 points
2953 Dollex-100
BSE also calculates a dollar-linked version of SENSEX and historical values of this
index are available since its inception
2954 BSE-100 index - Scrip Selection Criteria
The general guidelines for selection of constituents in BSE-100 are as follows
Trading Frequency The scrip should have been traded on 95 of the trading days
54
in the last three months Exceptions can be made for extreme reasons like scrip
suspension etc
Final Rank The scrip should figure in the top 200 companies listed by final rank
The final rank is arrived at by assigning 75 weighted to the rank on the basis of
three-month average full market capitalization and 25 weighted to the liquidity rank
based on three-month average daily turnover amp three-month average impact cost
IndustrySector Representation Scrip selection would generally take into account a
balanced sectorial representation of the listed companies in the universe of BSE
Track Record In the opinion of the BSE Index Committee the company should
have an acceptable track record
210 STOCK MARKET VOLATILITY
2101 Meaning
Volatility is a measure for variation of price of a financial instrument over time
Historic volatility is derived from time series of past market prices An implied
volatility is derived from the market price of a market traded derivative (in particular
an option) Volatility does not measure the direction of price changes merely their
dispersion This is because when calculating standard deviation (or variance) all
differences are squared so that negative and positive differences are combined into
one quantity Two instruments with different volatilities may have the same expected
return but the instrument with higher volatility will have larger swings in values over
a given period of time
For example a lower volatility stock may have an expected (average) return of 7
with annual volatility of 5 This would indicate returns from approximately negative
3 to positive 17 most of the time (19 times out of 20 or 95 via a two standard
deviation rule) A higher volatility stock with the same expected return of 7 but
with annual volatility of 20 would indicate returns from approximately negative
33 to positive 47 most of the time (19 times out of 20 or 95) These estimates
assume a normal distribution in reality stocks are found to be leptokurtotic
55
2102 Terminology used in volatility
Volatility as described here refers to the actual current volatility of a financial
instrument for a specified period (for example 30 days or 90 days) It is the volatility
of a financial instrument based on historical prices over the specified period with the
last observation the most recent price This phrase is used particularly when it is
wished to distinguish between the actual current volatility of an instrument and
actual historical volatility which refers to the volatility of a financial instrument
over a specified period but with the last observation on a date in the past
actual future volatility which refers to the volatility of a financial instrument
over a specified period starting at the current time and ending at a future date
(normally the expiry date of an options)
historical implied volatility which refers to the implied volatility observed from
historical prices of the financial instrument (normally options)
current implied volatility which refers to the implied volatility observed from
current prices of the financial instrument
future implied volatility which refers to the implied volatility observed from
future prices of the financial instrument
For a financial instrument whose price follows a random walk or wiener process the
width of the distribution increases as time increases This is because there is an
increasing profitability that the instruments price will be farther away from the initial
price as time increases However rather than increase linearly the volatility increases
with the square-root of time as time increases because some fluctuations are expected
to cancel each other out so the most likely deviation after twice the time will not be
twice the distance from zero
2103 Usefulness of volatility for Investors
Investors care about volatility for five reasons
1 The wider the swings in an investments price the harder emotionally it is to
not worry
2 Price volatility of a trading instrument can define position sizing in a portfolio
56
3 When certain cash flows from selling a security are needed at a specific future
date higher volatility means a greater chance of a shortfall
4 Higher volatility of returns while saving for retirement results in a wider
distribution of possible final portfolio values
5 Higher volatility of return when retired gives withdrawals a larger permanent
impact on the portfolios value
6 Price volatility presents opportunities to buy assets cheaply and sell when
overpriced
18
21 INTRODUCTION
Stock exchange is a mutual organization which provides trading facilities for stock
brokers and traders to trade stocks and other securities In common mens language
Stock markets refer to a market place where investors can buy and sell stocks The
price at which each buying and selling transaction takes place is determined by the
market forces (ie demand and supply for a particular stock)
Stock exchanges also provide facilities for the issue and redemption of securities as
well as other financial instruments and capital events including the payment of
income and dividends The securities traded on a stock exchange
include shares issued by companies unit trusts derivatives pooled investment
products and bonds To trade a security on a certain stock exchange it has to
be listed there Usually there is a central location at least for recordkeeping but trade
is less and less linked to such a physical place as modern markets are equipped with
electronic networks which gives them advantages of speed and cost efficiency of
transactions Only members are entitling to Trade on an exchange The initial offering
of stocks and bonds to investors is by definition done in the primary market and
subsequent trading is done in the secondary market A stock exchange is often the
most important component of a stock market Supply and demand in stock markets is
driven by various factors which as in all free markets affect the price of stocks
Usually there is no compulsion to issue stock via the stock exchange itself nor must
stock be subsequently traded on the exchange Such trading is said to be off
exchange or over-the-counter This is the usual way that derivatives and bonds are
traded Increasingly stock exchanges are part of a global market for securities
22 HISTORY OF WORLD STOCK MARKET
221 The First Stock Exchanges
It is believed that the first stock was established in 11th century France where
the courtiers de change were concerned with managing and regulating the debts of
Agricultural communities on behalf of the Banks Some stories suggest that the
origins of the term bourse come from the Latin bursa meaning a bag because in
19
13th century Bruges the sign of a purse (or perhaps three purses) hung on the front of
the house where merchants met
There were people in Pisa Verona Genoa and Florence who also began trading in
government securities during the 14th century This was only possible because these
were independent city states ruled by a council of influential citizens not by a duke
The Dutch later started joint stock companies which let shareholders invest in
business ventures and get a share of their profitsmdashor losses In 1602 the Dutch East
India Company issued the first shares on the Amsterdam Stock Exchange It was the
first company to issue stock and bonds In 1688 the trading of stocks began on a
stock exchange in London
On May 17 1792 twenty-four supply brokers signed the Buttonwood Agreement
outside 68 Wall Street in New York underneath a buttonwood tree On March 8
1817 properties got renamed to New York Stock amp Exchange Board In the 19th
century exchanges got substantiated to trade futures contracts and then choices
contracts generally famous as futures exchanges
222 London Stock Exchange - 1698
London Stock Exchange is arguably the oldest of the worlds major stock exchanges
The London Exchange can trace its history back to 1698 when its founder - John
Casting - began to organize the market in Jonathans Coffee-house via a simple list of
stock and commodity prices Today this exchange lists 3500 companies representing
84 countries
223 New York Stock Exchange - 1792
The New York Stock Exchange or NYSE is arguably the oldest and most well known
of all the American stock markets The NYSE was formed in 1792 when two dozen
stockbrokers from New York City had the idea to organize what was then a
disorganized and chaotic method of stock trading From those humble beginnings the
NYSE has continued to grow and today lists 2800 companies with a total
capitalization of nearly $20 trillion In 2007 a historic merger of equals created the
NYSE Euro next
20
224 Bombay Stock Exchange ndash 1875
The Bombay Exchange also known as Mumbai claims to be the oldest stock
exchange in Asia tracing its history back to 1875 In 2008 nearly 2000000 shares
of stock traded daily on the Bombay Exchange
225 American Stock Exchange - 1849
The American Stock Exchange or Amex is a relatively recent addition to the worlds
stock markets The history of this stock market begins with the Curb Exchange and
the California Gold Rush of 1849 The Amex played an important part in the
financial and business transactions associated with the mining industry in the 19th
century In 1921 the Amex expanded it niche role to include companies that did not
meet the strict standards of the NYSE In 1998 the NASDAQ purchased Amex and it
continues its history of being a niche market player and today specializes in
derivatives and stock options In late 2003 the American Stock Exchange regained
its independence After only six years under the control of NASDAQ The Amex
Membership Corporation completed an agreement to transfer control of the exchange
back to its membership
226 NASDAQ - 1971
Yes weve even included a relatively recent addition in this article on stock market
history And thats because we recognize the importance of this particular exchange
At one time most companies aspired to be traded on the NYSE That changed about
10 years ago and many large companies now trade on the NASDAQ Founded in
1971 the National Association of Securities Dealers Automated Quotation or
NASDAQ was the first stock exchange to recognize the role of electronics in stock
trading
Today stock exchanges operate around the world and they have become highly
regulated institutions Investors wanting to buy and sell shares must do so through a
share broker who pays to own a seat on the exchange Companies with shares traded
on an exchange are said to be listed and they must meet specific criteria which
varies across exchanges Most stock exchanges began as floor exchanges where
21
traders made deals face-to-face The largest stock exchange in the world the New
York Stock Exchange continues to operate this way but most of the worlds
exchanges have now become fully electronic The graphs below show (Chart 21 amp
22) world markets in both 1900 and 2000 and the anomalous growth of
the US market during this time While having 10 market share in 1900 India is
leading stock market but in 2000 market share of India is reduced drastically
Chart 21 Stock Market In 1900
Chart 22 Stock Market In 2000
Source Triumph of the optimists
22
12
254
2
11
10
43
7USA
UK
EUROLAND
JAPAN
SOUTH AFRICA
RASSIA
INDIA
AUSTRIA HUNGARY
LATIN AMERICA
47
8
13
13
211
6USA
UK
EUROLAND
JAPAN
CANADA
OTHER FORM 1900
NEW MARKET
22
23 THE ROLE OF STOCK EXCHANGES
The role of a stock exchange for any country appears to be vitally important For any
countries moving toward economic assimilation of enlistment and proficient
allocation of savings to productive investments stock market play imperative role
This is largely proficient through a sound financial architecture Quite a lot of the
most flourishing evolution economies have achieved stupendous increases in the
savings rate with lends a hand of stock exchanges Stock exchanges are indispensable
to support savings and investment in successful conversion countries Companies
often face Liquidation problems that the banking system is powerless or reluctant to
address With a functioning stock market it becomes easier for these firms to find
sources of capital in both domestic and international capital markets A properly
functioning stock exchange will not only help companies raise capital but also help
individuals and organizations to diversify their holdings With thinly traded markets
liquidity problems discourage participation by these investors in the financial system
As such investors will demand higher risk premiums to compensate for lack of
liquidity Thus the company in need of capital is placed at a disadvantage because
only relatively more expensive credit is available Solving this problem has helped
companies to raise more capital in the most successful transition economies while
failure to do so has constrained growth in some of the more backward states Role of
stock exchanges include the following29
231 Raising capital for businesses
The stock market is one of the most important sources for companies to raise money
This allows businesses to be publicly traded or raise additional capital for expansion
by selling shares of ownership of the company in a public market They encourage
investment by providing places for buyers and sellers to trade securities This
investment in turn enables corporations to obtain funds to expand their businesses30
29 Diamond Peter A (1967) The Role of a Stock Market in a General Equilibrium Model with
Technological Uncertainty American Economic Review 57 (4) 759ndash776
30 Gilson Ronald J Black Bernard S (1998) Venture Capital and the Structure of Capital Markets
Banks Versus Stock Markets Journal of Financial Economics 47 243ndash277
23
Corporations issue new securities in the primary market usually with the help of
investment bankers Company negotiates price and then makes the securities available
for its clients and other investors This is called an initial public offering (IPO)
In this primary market corporations receive the proceeds of stock sales After this
initial offering the securities are bought and sold in the secondary market The
corporation is not usually involved in the trading of its stock in the secondary market
therefore stock exchanges will essentially function as a secondary market By
providing investors the opportunity to trade financial instruments the stock exchanges
support the performance of the primary markets This arrangement makes it easier for
a corporation to raise the funds that they need to build and expand their businesses
Although corporations do not directly benefit from secondary market transactions the
managers of a corporation closely monitor the price of the corporationlsquos stock in
secondary markets Reasons for this concern involves the cost of raising new funds
for further business expansion the perceived strength of a company (and whether it
is vulnerable to a takeover) and of course their options and bonus packages
There are benefits and new obligations that come from raising capital through a public
offering
Benefits
Companylsquos access to capital will increase since you can contact more
potential investors
Company may become more widely known
Company may obtain financing more easily in the future if investor interest in
your company grows enough to sustain a secondary trading market in your
securities
Controlling shareholders such as the companys officers or directors may
have a ready market for their shares which means that they can more easily
sell their interests at retirement for diversification or for some other reason
24
Company may be able to attract and retain more highly qualified personnel if
it can offer stock options bonuses or other incentives with a known market
value
The image of company may be improved
Obligations
Company must continue to keep shareholders informed about the companys
business operations financial condition and management incurring additional
costs and new legal obligations
Company may be liable if you do not fulfill these new legal obligations
Company may lose some flexibility in managing your companys affairs
particularly when shareholders must approve your actions
Company public offering will take time and money to accomplish
232 Mobilizing savings for investment
When people draw their savings and invest in shares it leads to a
more rational allocation of resources because funds which could have been
consumed or kept in idle deposits banks are mobilized and redirected to
promote business activity with benefits for several economic sectors such
as agriculture commerce and industry resulting in stronger economic growth and
higher productivity levels of firms
233 Facilitating company growth
The smooth functioning of all these activities facilitates economic growth in that
lower costs and enterprise risks promote the production of goods and services as well
as employment In this way the financial system contributes to increased prosperity
An important aspect of modern financial markets however including the stock
markets is absolute discretion For example American stock markets see more
unrestrained acceptance of any firm than in smaller markets attention must be given to
25
the foreign Companies view acquisitions as an opportunity to expand product lines
increase distribution channels hedge against volatility increase its market share or
acquire other necessary business assets A takeover bid or a merger agreement
through the stock market is one of the simplest and most common ways for a
company to grow by acquisition or fusion
234 Profit sharing
Both casual and professional stock investors through dividends and stock
price increases that may result in capital gains will share in the wealth of profitable
businesses
235 Corporate governance
By having a wide and varied scope of owners companies generally tend to improve
on their management standards and efficiency in order to satisfy the demands of these
shareholders and the more stringent rules for public corporations imposed by public
stock exchanges and the government Consequently it is alleged that public
companies (companies that are owned by shareholders who are members of the
general public and trade shares on public exchanges) tend to have better management
records than privately-held companies (those companies where shares are not publicly
traded often owned by the company founders andor their families and heirs or
otherwise by a small group of investors) However some well-documented cases are
known where it is alleged that there has been considerable slippage in corporate
governance on the part of some public companies The dot-com bubbles in the early
2000s and the subprime mortgage crisis in 2007-08 are classical examples of
corporate mismanagement Companies like Petscom (2000) Enron
Corporation (2001) OneTel (2001) Sunbeam(2001) Webyan (2001) Adelphia
(2002) MCI World Com (2002) Parmalat (2003) American International Group
(2008) Lehman Brothers (2008) and Satyam Computer Service(2009) were among
the most widely scrutinized by the media
26
236 Creating investment opportunities for small investors
As opposed to other businesses that require huge capital outlay investing in shares is
open to both the large and small stock investors because a person buys the number of
shares they can afford Therefore the Stock Exchange provides the opportunity for
small investors to own shares of the same companies as large investors
The liquidity that an exchange provides affords investors the ability to quickly and
easily sell securities This is an attractive feature of investing in stocks compared to
other less liquid investments such as real estate
237 Government capital-raising for development projects
Governments at various levels may decide to borrow money in order to finance
infrastructure projects such as sewage and water treatment works or housing estates
by selling another category of securities known as bonds These bonds can be raised
through the Stock Exchange whereby members of the public buy them thus loaning
money to the government The issuance of such bonds can obviate the need to directly
tax the citizens in order to finance development although by securing such bonds
with the full faith and credit of the government instead of with collateral the result is
that the government must tax the citizens or otherwise raise additional funds to make
any regular coupon payments and refund the principal when the bonds mature
238 Barometer of the economy
Form the history of many countries it has shown that the price of share and other
assets is an important part of the dynamics of economic activity The price of these
assets can influence or be an up and coming economy Many times the stock market is
considered the primary indicator of a countrylsquos economic development and strength
If the stock market is rising it tends to be associated with increased business and
investments and if the stock market if falling associated with deceased business and
investments It can also be observed that share prices also affect the wealth of
households and their consumption At the stock exchange share price rise or fall may
depending largely on market forces and sentiments When the economy is stable or
growing the share prices tense to raise or remain stable but when economic face
recession depression or financial crisis result in stock market crash Therefore the
27
movement of share prices and in general of the stock indexes can be an indicator of
the general trend in the economy
24 MAJOR STOCK EXCHANGES
Twenty Major Stock Exchanges Of The World Market Capitalization amp Year-to-date
Total Turnover at the end of August 2009
Table 21 Major Stock Exchanges of World
(August 2009 Figure in Million USD) Region Stock Exchange Market Value
Total Share
Turnovers
America Satildeo Paulo Stock Exchange 103251840 36195900
America Toronto Stock Exchange 143287700 79819310
America New York Stock Exchange 1084200190 1215862060
Asia-Pacific Australian Securities Exchange 106651320 56091280
Asia-Pacific Bombay Stock Exchange 108257200 17117620
Asia-Pacific Hong Kong Stock Exchange 194551770 97022760
Asia-Pacific Korea Exchange 72712530 105047380
Asia-Pacific National Stock Exchange of India 101910900 50665230
Asia-Pacific Shanghai Stock Exchange 214275680 331576850
Asia-Pacific Shenzhen Stock Exchange 59632020 170125680
Asia-Pacific Tokyo Stock Exchange 347860250 267598330
Europe Euro next 260509760 119596220
Europe Frankfurt Stock Exchange (Deutsche Boumlrse) 120429200 158973670
Europe London Stock Exchange 256049110 232151850
Europe Madrid Stock Exchange (Bolsas y Mercados
Espantildeoles)
117852560 104075110
Europe Milan Stock Exchange (Borsa Italiana) 63667480 56575930
Europe Nordic Stock Exchange Group OMX1 78114630 50304990
Europe Swiss Exchange 99235640 52086750
Note includes the Copenhagen Helsinki Iceland Stockholm Tallinn Riga and
Vilnius Stock Exchanges
Sources World Federation of Exchanges - Statistics Monthly
Remarks There are 2 pending major mergers NASDAQ with OMX and London
Stock Exchange with Milan Stock Exchange
28
Chart 23 Market Value
Chart 24 Total Share Turnovers
Source From the table 21
000 400000000 800000000 1200000000
Satildeo Paulo Stock Exchange
Toronto Stock ExchangeNew York Stock Exchange
Australian Securities ExchangeBombay Stock Exchange
Hong Kong Stock ExchangeKorea Exchange
National Stock Exchange of India
Shanghai Stock ExchangeShenzhen Stock Exchange
Tokyo Stock ExchangeEuro next
Frankfurt Stock Exchange (Deutsche Boumlrse)
London Stock ExchangeMadrid Stock Exchange (Bolsas y hellip
Milan Stock Exchange (Borsa Italiana)Nordic Stock Exchange Group OMX1
Swiss Exchange Market hellip
000 500000000 1000000000 1500000000
Satildeo Paulo Stock ExchangeToronto Stock Exchange
New York Stock ExchangeAustralian Securities Exchange
Bombay Stock ExchangeHong Kong Stock Exchange
Korea ExchangeNational Stock Exchange of India
Shanghai Stock ExchangeShenzhen Stock Exchange
Tokyo Stock ExchangeEuro next
Frankfurt Stock Exchange (Deutsche hellipLondon Stock Exchange
Madrid Stock Exchange (Bolsas y hellipMilan Stock Exchange (Borsa Italiana)Nordic Stock Exchange Group OMX1
Swiss Exchange Total Share hellip
29
25 REQUIREMENTS BY STOCK EXCHANGE
Companies have to meet the requirements of the exchange in order to have their
stocks and shares listed and traded there but requirements vary by stock exchanges
251 Bombay Stock Exchange
Bombay Stock Exchange (BSE) has requirements for a minimum market
capitalization of Rs250 Million and minimum public float equivalent to Rs100
Million31
252 London Stock Exchange
The main market of the London Stock Exchange has requirements for a minimum
market capitalization (pound700000) three years of audited financial statements
minimum public float (25 per cent) and sufficient working capital for at least 12
months from the date of listing
253 NASDAQ Stock Exchange
To be listed on the NASDAQ a company must have issued at least 125 million shares
of stock worth at least $70 million and must have earned more than $11 million over
the last three years 32
254 New York Stock Exchange
To be listed on the New York Stock Exchange (NYSE) a company must have issued
at least a million shares of stock worth $100 million and must have earned more than
$10 million over the last three years 33
255 Other types of exchanges
In the 19th century exchanges were opened to trade forward
contracts on commodities Exchange traded forward contracts are called futures
contracts These commodity exchanges later started offering future contracts on other
31 wwwbseindiacomaboutabintrobselistsecasp 32 NASDAQ Corporate -NASDAQ Listing Information wwnasdaqcomaboutlisting_informationstm 33 wwwnysecomFramesethtmldisplayPage=listed
30
products such as interest rates and shares as well as Options contracts They are now
generally known as futures exchanges
26 OWNERSHIP
Stock exchanges originated as mutual organizations owned by its member stock
brokers There has been a recent trend for stock exchanges to demutualize where the
members sell their shares in an initial public offering In this way the mutual
organization becomes a corporation with shares that are listed on a stock exchange
Examples are
Australian Securities Exchange (1998) Euro next (merged with New York Stock
Exchange) NASDAQ (2002) The New York Stock Exchange (2005) Bolsas
Mercados Espanoles and the Sao Paulo Stock Exchange (2007) The Shenzhen and
Shanghai stock exchanges can be characterized as quasi-state institutions insofar as
they were created by government bodies in China and their leading personnel are
directly appointed by the China Securities Regulatory Commission
27 HISTORY OF INDIAN STOCK MARKET
The stock exchange in Mumbai is more than 100 years old The origin of the stock
market in India dates back to the end of the eighteenth century when long term
negotiable securities were first issued The real beginning however occurred in the
middle of the nine teeth century after the enactment of the Companies Act in 1850
which introduced the feature of limited liability and generated investor interest in
corporate securities
The Native Share and Stock Brokerslsquo Association now known as the Bombay Stock
Exchange (BSE) was formed in Bombay (now Mumbai) in 1875 This was followed
by the formation of association in Ahmadabad in 1894 Calcutta (now Kolkata) in
1908 and Madras (now Chennai) in 1937 In order to promote the orderly
development of the stock market the central government introduced a comprehensive
legislation called the Securities Contracts (Regulation) Act 1956
31
The Calcutta Stock Exchange (CSE) was the largest stock exchange in India till the
1960s In 1961 there were 1203 listed companies across the various stock exchanges
of the country Of these 576 were listed on the CSE and 297 on the BSE However
during the later half of the 1960s the relative importance of the CSE declined while
that of the BSE increased sharply
One of the oldest stock markets in Asia the Indian Stock Markets have a 200 years
old history
Table 22 Origin of Indian Stock Market
Year Events
18th
Century
East India Company was the dominant institution and by end of the century business in its loan
securities gained full momentum
1830s Business on corporate stocks and shares in Bank and Cotton presses started in Bombay Trading list
by the end of 1839 got broader
1840s Recognition from banks and merchants to about half a dozen brokers
1850s Rapid development of commercial enterprise saw brokerage business attracting more people into
the business
1860s The number of brokers increased to 60
1860-61 The American Civil War broke out which caused a stoppage of cotton supply from United States of
America marking the beginning of the Share Mania in India
1862-63 The number of brokers increased to about 200 to 250
1865 A disastrous slump began at the end of the American Civil War (as an example Bank of Bombay
Share which had touched Rs 2850 could only be sold at Rs 87)
1874 With the rapidly developing share trading business brokers used to gather at a street (now well
known as Dalal Street) for the purpose of transacting business
1875 The Native Share and Stock Brokers Association (also known as The Bombay Stock
Exchange) was established in Bombay
1880s Development of cotton mills industry and set up of many others
1894 Establishment of The Ahmadabad Share and Stock Brokers Association
1880 -
90s
Sharp increase in share prices of jute industries in 1870s was followed by a boom in tea stocks and
coal
1908 The Calcutta Stock Exchange Association was formed
1920 Madras witnessed boom and business at The Madras Stock Exchange was transacted with 100
brokers
1923 When recession followed number of brokers came down to 3 and the Exchange was closed down
32
1934 Establishment of the Lahore Stock Exchange
1936 Merger of the Lahore Stock Exchange with the Punjab Stock Exchange
1937 Re-organization and set up of the Madras Stock Exchange Limited (Pvt) Limited led by
improvement in stock market activities in South India with establishment of new textile mills and
plantation companies
1940 Uttar Pradesh Stock Exchange Limited and Nagpur Stock Exchange Limited was established
1944 Establishment of The Hyderabad Stock Exchange Limited
1947 Delhi Stock and Share Brokers Association Limited and The Delhi Stocks and Shares Exchange
Limited were established and later on merged into The Delhi Stock Exchange Association
Limited
Sources wwwsurfindiacom wwwappuonlinecom
271 Post Independence Scenario
The depression witnessed after the Independence led to closure of a lot of exchanges
in the country Lahore Stock Exchange was closed down after the partition of India
and later on merged with the Delhi Stock Exchange Bangalore Stock Exchange
Limited was registered in 1957 and got recognition only by 1963 Most of the other
Exchanges were in a miserable state till 1957 when they applied for recognition under
Securities Contracts (Regulations) Act 1956 The Exchanges that were recognized
under the Act were
Bombay Calcutta Madras Ahmadabad Delhi Hyderabad Bangalore Indore
272 Many more stock exchanges were established during 1980s
namely
Cochin Stock Exchange (1980)
Uttar Pradesh Stock Exchange Association Limited (at Kanpur 1982)
Pune Stock Exchange Limited (1982)
Ludhiana Stock Exchange Association Limited (1983)
Gauhati Stock Exchange Limited (1984)
Kanara Stock Exchange Limited (at Mangalore 1985)
33
Magadh Stock Exchange Association (at Patna 1986)
Jaipur Stock Exchange Limited (1989)
Bhubaneswar Stock Exchange Association Limited (1989)
Saurashtra Kutch Stock Exchange Limited (at Rajkot 1989)
Vadodara Stock Exchange Limited (at Baroda 1990)
Coimbatore Stock Exchange
Meerut Stock Exchange
At present there are twenty one recognized stock exchanges in India which does not
include the Over The Counter Exchange of India Limited (OTCEI) and the National
Stock Exchange of India Limited (NSEIL)
Government policies during 1980s also played a vital role in the development of the
Indian Stock Markets There was a sharp increase in number of Exchanges listed
companies as well as their capital which is visible from the following table
Table 23 Pattern of Growth of Stock Exchanges
Source SEBI annual report
273 Trading Pattern of the Indian Stock Market
Indian Stock Exchanges allow trading of securities of only those public limited
companies that are listed on the Exchange(s) They are divided into two categories
S
No
As on 31st December 1946 1961 1971 1980 1991 1995 2000 2005
1 No of Stock Exchanges 7 7 8 9 20 22 23 23
2 No of Listed Cos 1125 1203 1599 2265 6229 8593 9413 4731
5 Market value of Capital
of Listed Cos (Cr Rs)
971 1292 2675 6750 110279 478121 6319212 478121
34
Chart 25 Trading Pattern of the Indian Stock Market
Source wwwbseindiacom
274 Types of Transactions
The flowchart below describes the types of transactions that can be carried out on the
Indian stock exchanges
Chart 26 Types of Transactions
Source wwwbseindiacom
Listed Securities of Public limited companies
Specified securities (forward List)
Equity shares of company that are
- Dividend paying
- growth orinted companies
- paid up capital of atleast Rs50 million
- Market capitalisation of atleast Rs100 million
- has more than 20000 shareholders
Non specicied Securities (Cash List)
equity shares of companies not covered in specified securities
Transactions on Indian Stock Exchanges
Spot Delivery Transactions
Forward Transactions
35
Spot Delivery Transactions
Includes transactions that require delivery and payment within stipulated time
period at the time of entering into the contract
This period shall not be more than 14 days following the date of the contract
Forward Transactions
Transactions in which delivery and payment can be extended by further period
of 14 days each
The overall period should not exceed 90 days from the date of contract
Transactions permitted only in case of specified shares
275 Indian stock exchange allows a member broker to perform
following activities
Act as an agent
Buy and sell securities for clients and charge commission for the same
Act as a trader or dealer as a principal
Buy and sell securities on their account and risk
276 Over The Counter Exchange of India (OTCEI)
Traditionally trading in Stock Exchanges in India followed a conventional style
where people used to gather at the Exchange and bids and offers were made by open
outcry This age-old trading mechanism in the Indian stock markets used to create
much functional inefficiency Lack of liquidity and transparency long settlement
periods and benami transactions are a few examples that adversely affected investors
In order to overcome these inefficiencies OTCEI was incorporated in 1990 under the
Companies Act 1956 OTCEI is the first screen based nationwide stock exchange in
India created by Unit Trust of India Industrial Credit and Investment Corporation of
India Industrial Development Bank of India SBI Capital Markets Industrial Finance
Corporation of India General Insurance Corporation and its subsidiaries and Can
Bank Financial Services
36
Chart 27 Securities traded on the OTCEI
Source wwwbseindiacom
Listed Securities
Securities of the companies listed on the OTC
Can be bought or sold at any OTC counter across India
Should not be listed anywhere else
Permitted Securities
Certain securities (Shares and debentures listed on other exchanges)
Unites of Mutual funds can be traded
Initiated Debentures
An equity holding a minimum of one lakh debentures of a particular scrip can
offer them for trading on the OTC
Advantages of OTCEI
Greater liquidity and lesser risk of intermediary charges due to widely spread trading
mechanism across India The screen-based scrip less trading ensures transparency and
accuracy of prices Faster settlement and transfer process as compared to other
exchanges Shorter allotment procedure (in case of a new issue) than other exchanges
277 National Stock Exchange
In order to lift the Indian stock market trading system at par with the international
standards On the basis of the recommendations of high powered Pherwani
Securities teaded on the
OTCEI
Listed Securities
Permitted Securities
Initiated Debentures
37
Committee the National Stock Exchange was incorporated in 1992 by Industrial
Development Bank of India Industrial Credit and Investment Corporation of India
Industrial Finance Corporation of India all Insurance Corporations selected
commercial banks and others
2771 NSE provides exposure to investors in two types of markets
namely
Wholesale debt market
Capital market
Wholesale Debt Market - Similar to money market operations debt market
operations involve institutional investors and corporate bodies entering into
transactions of high value in financial instruments like treasury bills government
securities commercial papers etc
Capital market- A capital market is a market for securities (debt or equity) where
business enterprises and governments can raise long term funds It is defined as a
market in which money is defined as a market in which money is provided for periods
longer than a year34 as the raising of short term funds takes place on other markets
Capital markets may be classified as primary markets and secondary markets In
primary markets new stock or bond issues are sold to investors via a mechanism
known as underwriting In the secondary markets existing securities are sold and
bought among investors or traders usually on a securities exchange over the counter
or elsewhere
278 Trading at NSE amp BSE
Fully automated screen-based trading mechanism
Strictly follows the principle of an order-driven market
Trading members are linked through a communication network
34 Steven M Sheffrin (2003) Economics Principles in action Upper Saddle River Pearson Prentice
Hall
38
This network allows them to execute trade from their offices
The prices at which the buyer and seller are willing to transact will appear on
the screen
When the prices match the transaction will be completed
A confirmation slip will be printed at the office of the trading member
2781 Advantages of trading at NSE amp BSE
Integrated network for trading in stock market of India
Fully automated screen based system that provides higher degree of
transparency
Investors can transact from any part of the country at uniform prices
Greater functional efficiency supported by totally computerized network
28 THE BOMBAY STOCK EXCHANGE
Formerly the Stock Exchange Mumbai popularly called Bombay Stock Exchange
or BSE is the oldest stock exchange in Asia and has the greatest number of listed
companies in the world with 4700 listed as of August 2007 35
It is located at Dalal Street Mumbai India On 31 December 2007 the equity market
capitalization of the BSE was US $ 179 trillion making it the largest stock exchange
in South Asia and the 12th largest in the world
With over 4700 Indian companies list on the stock exchange [10]
and it has a
significant trading volume The BSE SENSEX (SENSITIVE INDEX) also called the
―BSE 30 is a widely used market index in India and Asia Though many other
exchanges exist BSE and the National Stock Exchange of India account for most of
the trading in shares in India
35 World Federation of Exchanges (2007) wwwworld-exchangesorg
39
281 History of the Bombay Stock exchange
Trading in securities has been in vogue in India for a little over 200 years Trading in
securities dates back 1793 most of them being transactions in loan securities of the
East India Company The broking community prospered as there was a rise in prices
which led to a share mania during 1861-65 This bubble burst in 1865 when the
American Civil War ended The brokers realized that investor confidence in the
securities market could be sustained only by organizing themselves into a regulated
body with defined rules and regulations The realization resulted in formation of ―The
Native Share and Stock Brokerslsquo Association which later came to be known as the
Bombay Stock Exchange In 1875 these brokers assembled at a place now called
Dalal Street
The Bombay Stock Exchange is a voluntary nonprofit making association of broker
members It emerged as a premier stock exchange after the 1960 The increased pace
of industrialization caused by the two world wars protection to the domestic industry
and the governmentlsquos fiscal policies aided the growth of new issues which in turn
helped the BSE to prosper The BSE dominated the Indian Capital Market by
accounting for more than 60 per cent of the all Indian turn over
Until 1992 the BSE operated like a closed club of selected members With the
securities scam outburst in 1992 and the SEBI taking over the rains of the Stock
Market the BSE had to bring about changes in its operational policies Until March
1995 the BSE had an open outcry system of trading However when faced with stiff
competition from NSE the countrylsquos first modern computerized and professionally
managed stock exchange set up in 1994 the BSE had to change its system of trading
and operation
On 14 March 1995 the BSE turned to electronic trading whereby brokers trade using
computers This system is known as the BSE On-line Trading System (BOLT)
The introduction of BOLT helped in improving trading volumes significantly
reducing the spread between buy and sell orders better trading in odd lot shares fixed
income instruments and dealings in the renunciation of rights shares
40
In 1995 BOLT was limited to Mumbai whereas the NSE was operating at the
national level As a result the BSE submitted a proposal for allowing installation of
terminals connected to BOLT in centers outside Mumbai After rejecting the proposal
four times on 29 october 1996 the SEBI finally allowed the BSE to use its BOLT
system nationwide Later the BSE set up a central depository system to dematerialize
shares and promote demate Account (trading)
282 Hours of Operation
Beginning of the Day Session 800 to 900
Trading Session 900 to 1530
Position Transfer Session 1530 to 1550
Closing Session 1550 to 1605
Option Exercise Session 1605 to 1635
Margin Session 1635 to 1650
Query Session 1650 to1735
End of Day Session 1735
The hours of operation for the BSE quoted above are stated in terms of the local time
(ie GMT+530) in Mumbai India
BSElsquos normal trading sessions are on all days of the week except Saturdays Sundays
and Holidays declared by the Exchange in advance 36
283 Services of BSE
BSE also had a wide range of services to empower investors and facilitate smooth
transactions These services are as follows
2831 Investor Services
The Dept of investor services redresses grievances of investors BSE was the first
exchange in the country to provide an amount of Rs 1 million towards the investor
36 Asia Technical Analysis with Phil Smith wwwreutersindianet
41
protection fund it is an amount higher than that of any exchange in the country BSE
launched a nationwide investor awareness program ―Safe Investing in the Stock
Market under which 264 programmers were held in more than 200 cities
2832 The BSE Online Trading (BOLT)
BSE on line Trading (BOLT) facilities on-line screen based trading in securities
BOLT is currently operating in 25000 trader work stations located across over 399
cities in India
2833 BSEWEBXcom
In February 2001 BSE introduced the worldlsquos first centralized exchange based
Internet trading system BSEWEBXcom This initiative enables investors anywhere
in the world to trade on BSE platform
2834 Surveillance
BSElsquos Online Surveillance System (BOSS) monitors on a real time basis the price
movements volume position and real time measurements of the default risk market
reconstruct and generation of cross market alerts
2835 BSE Training Institute
BTI imparts capital market training and certification in collaboration with reputed
management institutes and universities It offers over 40 courses on various aspects of
the capital mark and financial sector More than 20000 people have attended the BTI
program
284 Awards
Fowling awards were given to BSE
The world council of Corporate Governance has awarded the Golden Peacock
Global CSR Award for BSElsquos initiatives in corporate social responsibility
The Annual Reports and Accounts of BSE for the year ended March 312006 and
42
March 312007 have been awarded the ICAI awards for excellence in financial
reporting
The Human Resource Management at BSE has won the Asia-Pacific HRM awards
for its efforts in employer branding through talent management at work health
management at work and excellence in HR through technology
Drawing from its rich past and its equally robust performance in the recent times
BSE will continue to remain an icon in the Indian Capital Market
285 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 days closing price is taken for computation of Index closure
The use of Index Closure Algorithm prevents any intentional manipulation of the
closing index value
286 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 affect the
index values The BSE Index Cell does the day-to-day maintenance of the index
within the broad index policy framework set by the BSE Index Committee The BSE
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 BSE Index Committee comprises
of capital market expert fund managers market participants and members of the BSE
Governing Board
43
287 On-Line Computation of the Index
During trading hours value of the Index is calculated and disseminated on real time
basis This is done automatically on the basis of prices at which trades in Index
constituents are executed
288 Adjustment for Bonus Rights and Newly Issued Capital
SENSEX calculation needs to be adjusted for issue of Bonus or 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 BSE Index Cell the base value is adjusted which is used to alter
market capitalization of the component stocks to arrive at the SENSEX value The
BSE Index Cell keeps a close watch on the events that might affect the index on a
regular basis and carries out daily maintenance of all the 19 Indices
2881 Adjustments for Rights Issues
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 (ex-right) price An offsetting or
proportionate adjustment is then made to the Base Market capitalization
2882 Adjustments for Bonus Issue
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
2883 Other Issues 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
buy-back of shares corporate restructuring etc
44
289 Listing Categories
Before badla was resumed in 1996 there were only two categories of securities listed
on the BSE the specified group of shares comprising The securities in which carry
forward deals were allowed and the cash group shares in which no carry forward deals
were permitted Later it was observed that the facility of carry forward was not being
used in all the 94 scrips in the specified group Hence after badla was resumed the
size of the specified group was reduced to 32 scrips on 3 April 1996 The BSE later
decided to regroup the existing A and B group shares into three categories The BSE
delisted 637 companies for a period of 3 years during 2004-05 for non-compliance of
listing agreements
A Group This group consists of large stock with turnover and high floating stock
with large market capitalization In other words scrips with more liquidity and high
networth are included in this group At present there are 150 scrips in this group
B1 Group This group includes scrips of quality companies with equity above Rs 3
crore with high growth potential and trading frequency No carry forward facility was
allowed in this group in June 2000 there were 1803 scrips in this group
B2 Group Scrips in this group were just like those of B1 but with fortnightly
settlement However in September 1996 the BSE introduced weekly settlement for all
scrips listed on the exchange thus doing away with the distinction between the B1 and
B2 groups On June 2000 there were 3219 scrips in this group
Z Group Subsequently a Z group was introduced in 1999 with scrips of companies
that do not meet the rules regulations and stipulations laid down by the exchange It
is a buyer beware company These are some 300 scrips in the group All Z category
stocks result in delivers
F Group A new Flsquo group pertaining to debt market segment was started with effect
from 9 September 1996
S Group The BSE reduced post-public issue capital base requirement from Rs10
crore to Rs3 crore to attract listing by companies with a smaller capital base It also
45
started a new trading segment small cap stock segment known as the Slsquo segment
Corporate with minimum turnover of an equal amount would be eligible to list scrips
on this segment In addition stocks listed on the regional exchanges would also be
able to list on the lsquoSlsquo segment subject to meeting certain criteria
2810 Base Market capitalization Adjustment
The formula for adjusting the Base Market capitalization is as follows
New Base Market Capitalization (NBMC)
New Market capitalization
NBMC = Old Base Market capitalization x mdashmdashmdashmdashmdashmdashmdashmdashmdashmdashmdash
Old Market capitalization
To illustrate suppose a company issues right shares which increases the market
capitalization of the shares of that company by say Rs100 crores The existing Base
Market capitalization (Old Base Market capitalization) say is Rs2450 crores and the
aggregate market capitalization of all the shares included in the index before the right
issue is made is say Rs4781 crore The New Base Market capitalization will then
be
2450x (4781+100)
_____________________ = Rs250124 crores
4781
This figure of Rs 250124 crore will be used as the Base Market capitalization for
calculating the index number from then onwards till the next base change becomes
necessary
Index Review Frequency
The BSE 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
29 STOCK MARKET INDEX
The stock market index is the most important indices of all as it measures overall
market sentiment through a set of stocks that representative of the market The stock
46
market index is a barometer of the market behavior It reflects direction and indicates
day-to-day fluctuations in stock prices The market index reflects expectations about
the behavior of the economy as a whole It is a precursor of economic cycles The
function of a stock index is to provide investors with information regarding the
average share price in the market An ideal index must represent changes in the prices
of the scrips and reflect price movements of typical shares for better market
representation Stock index is a barometer of a nationlsquos economic health as market
prices reflect expectations about the economylsquos performance Stock indices termed as
leading economic as they indicate what is going to happen in the economy in the
future The returns generated in the stock market are based on future expectations A
good market index incorporates a set of scrips which have high market capitalization
and high liquidity Market capitalization is the sum of the market value of all the
stocks included in the index The market value is derived by multiplying the price of
the share outstanding In other words the bid-ask spread is minimum The index on a
day is calculated as the percentage of the aggregate market value of the set of scrips
incorporated in the index on that day to the average market value of the same scrips
during the base period
291 Definition of an Index
A price index is such as the stock market price of the individual securities in the
market It reflects the overall price or return movements of a group of securities
Movements in an index are determined by sample weighting and computational
procedure Sample is normally generated by random selection or try a non random
selection technique designed to incorporate desired characteristics are used to select
sample shares rather than by completely random selection Major criteria for selection
are market activity due representation to various industrial groups and to major stock
exchanges
292 Global Stock Market Indices
2921 The Dow Jones Industrial averagersquos
It is the most widely watched and quoted index because of its long existence The
Dow has 30 constituents and it follows the methodology of price based weighted
47
Changes to stocks included in the Dow are infrequent three stocks were
addeddropped in 1991 four in 1997 and four in 1999 The addition of Microsoft and
Intel in 1999 was the first inclusion of Nasdaq market stocks to the Dow 30
2922 The Nasdaq composite index
The index is the market capitalization weighted of prices for all the stocks listed in the
Nasdaq stock market The Nasdaq composite began on 8 February 1971 with a base
of 100
2923 The Nasdaq 100 index
Nasdaq 100 comprises the largest computer software and telecom stocks by market
capitalization on the Nasdaq For a company to be included in the Nasdaq 100 it must
have a minimum average trading volume of 100000 shares per day and must have
been trading on a major exchange for at least a year or two
2924 The S amp P 500 index
This index comprises 500 biggest publicly traded companies in the US by market
capitalization Most money managers treat the S amp P 500 as a proxy for the US stock
market The S amp P 500 tries to cover all major areas of US economy To be included a
company must be profitable the prospective company must not be closely hold and
must have a large trading volume for its shares
2925 The FTSE 100
The FTSE 100 consists of the largest 100 companies by full market Value listed on
the London Stock Exchange The FTSE 100 is the benchmark index to indicate the
performance of the European market It is a market capitalization weighted index that
also considers the free float weighted of individual stocks before including them in
the index
2926 The MSCI Indices
Include the MSCIEAFE (Europe Australia and Far East) MSCI Europe MSCI
world MSCI (EMF) and MSCI Pacific Basin Indices
48
The MSCI world Index is a free float adjusted market capitalization index that is
designed to measure global developed market equity performance As of April 2002
the MSCI world Index consisted of the MSCI world Index consisted of the following
23 developed market country indices
Australia Austria Belgium Canada Denmark Finland France Germany Greece
Hong Kong Ireland Italy Japan Netherlands New Zealand Norway Singapore
Portugal Spain Sweden Switzerland United Kingdom and the United States of
America
293 Methodology for Calculating The Index
2931 Price Weighted Index
In this method the price of each stock in the index is summed up which is then
equated to an index starting value An arbitrary date is set as the base and the
Laspeyerlsquos Price Index which measures price changes against a fixed base period
quantity weight is used In case of a stock split the market price of the stock falls and
these results in less weighted in the index The Dow Jones Industrial Average and
Nikkie 225 are price-weighted indices
2932 Equal Weighting
In this method each stocklsquos percentage weight in the index is equal and hence all
stocks have an equal influence on the index movement The value line index at
Kansas City Board of Trade (KCBT) is an equal weighted index
2933 Market Capitalization Weighted
29331 Full Market Capitalization Method
In this method the number of shares outstanding multiplied by the market price of a
companylsquos share determines the scriplsquos weighted in the index The shares with the
highest market capitalization would have a higher weighted and would be most
influential in this type of index Eg S amp P 500 Index in USA and S amp P CNX Nify in
India
49
29332 Modified Capitalization Weighted
This method seeks to limit the influence of the largest stocks in the index which
otherwise would dominate the entire index This method sets a limit on the largest
stock or a group of stocks The NASDAQ 100 Index is calculated by using this
method
294 Free Float Market Capitalization Method
2941 Concept
Free float methodology refers to an index construction methodology that takes in to
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 Strategic holding government 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
All BSE indices with exception of BSE-PSU index have adopted the free-float
methodology
2942 Definition of Free Float
Share holding of investor that would not in the normal course come into the
open market for trading are treated as ―Controlling Strategic Holding and
hence not included in free float specifically the following categories of
holding are generally excluded from the definition of free float
Shares hold by foundersdirectorsacquires which has control element
Shares held by person with ―Controlling Interestlsquo
Shares held by Govt as promoters
50
Holding through the FDI Route
Strategic Stakes by private corporate bodiesindividuals
Equity held by employee welfare trusts
Locked-in-shares and shares which not be sold in the open market in normal
course
2943 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-agrave-Vis an investible
index This enables an apple-to-apple comparison thereby facilitating better
evaluation of performance of active managers
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 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
The free float methodology of index construction is considered to be an industry best
practice and all major index providers like MSCI FTSE SampP 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
51
29441 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 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 055 means that only 55 of the market
capitalization of the company will be considered for index calculation
Table 24 Free-float Bands
Free-Float Free-Float Factor Free-Float Free-Float Factor
gt0 - 5 005 gt50 - 55 055
gt5 - 10 010 gt55 - 60 060
gt10 - 15 015 gt60 - 65 065
gt15 - 20 020 gt65 - 70 070
gt20 - 25 025 gt70 - 75 075
gt25 - 30 030 gt75 - 80 080
gt30 - 35 035 gt80 - 85 085
gt35 - 40 040 gt85 - 90 090
gt40 - 45 045 gt90 - 95 095
gt45 - 50 050 gt95 - 100 100
Source wwwbseindiacom
295 BSE Indices
For the premier stock exchange that pioneered the securities transaction business
in India over a century of experience is a proud achievement A lot has changed since
1875 when 318 persons by paying a then princely amount of Re 1 became members
of what today is called Bombay Stock Exchange Limited (BSE) Over the decades
the stock market in the country has passed through good and bad periods The journey
52
in the 20th century has not been an easy one Till the decade of eighties there was no
measure or scale that could precisely measure the various ups and downs in the Indian
stock market BSE in 1986 came out with a Stock Index-SENSEX- that subsequently
became the barometer of the Indian stock market
The launch of SENSEX in 1986 was later followed up in January 1989 by
introduction of BSE National Index (Base 1983-84 = 100) It comprised 100 stocks
listed at five major stock exchanges in India - Mumbai Calcutta Delhi Ahmadabad
and Madras The BSE National Index was renamed BSE-100 Index from October 14
1996 and since then it is being calculated taking into consideration only the prices of
stocks listed at BSE BSE launched the dollar-linked version of BSE-100 index on
May 22 2006
With a view to provide a better representation of the increasing number of listed
companies larger market capitalization and the new industry sectors BSE launched
on 27th May 1994 two new index series viz the BSE-200 and the DOLLEX-200
Since then BSE has come a long way in attuning itself to the varied needs of
investors and market participants In order to fulfill the need for still broader
segment-specific and sector-specific indices BSE has continuously been increasing
the range of its indices BSE-500 Index and 5 sectorial indices were launched in 1999
In 2001 BSE launched BSE-PSU Index DOLLEX-30 and the countrys first free-
float based index - the BSE TEC Index Over the years BSE shifted all its indices to
the free-float methodology
BSE disseminates information on the Price-Earnings Ratio the Price to Book Value
Ratio and the Dividend Yield Percentage on day-to-day basis of all its major indices
The values of all BSE indices are updated on real time basis during market hours and
displayed through the BOLT system BSE website and news wire agencies
All BSE Indices are reviewed periodically by the BSE Index Committee This
Committee which comprises eminent independent finance professionals frames the
broad policy guidelines for the development and maintenance of all BSE indices The
BSE Index Cell carries out the day-to-day maintenance of all indices and conducts
research on development of new indices
53
2951 BSE-100 Index
A broad-based index the BSE-100 was formerly known as the BSE National index
This Index has 1983-84 as the base year and was launched in 1989 In line with the
shift of the BSE Indices to the globally accepted Free-Float methodology BSE-100
was shifted to Free-Float methodology effective from April 5 2004 The method of
computation of Free-Float index and determination of free-float factors is similar to
the methodology for SENSEX
Table 25 Index Specification
Base Year 1983-84
Base Index Value 100
Date of Launch 3-Jan-89
Method of calculation Launched on full market capitalization
method and effective April 05 2004
calculation method shifted to free-float
market capitalization
Number of scrips 100
Index calculation frequency Real Time
Source wwwbseindiacom
2952 Base Year
The financial year 1983-84 has been chosen as the base year The price stability
during that year and proximity to the index series were the main consideration for
choice of 1983-84 as the base year The base value was fixed at 100 points
2953 Dollex-100
BSE also calculates a dollar-linked version of SENSEX and historical values of this
index are available since its inception
2954 BSE-100 index - Scrip Selection Criteria
The general guidelines for selection of constituents in BSE-100 are as follows
Trading Frequency The scrip should have been traded on 95 of the trading days
54
in the last three months Exceptions can be made for extreme reasons like scrip
suspension etc
Final Rank The scrip should figure in the top 200 companies listed by final rank
The final rank is arrived at by assigning 75 weighted to the rank on the basis of
three-month average full market capitalization and 25 weighted to the liquidity rank
based on three-month average daily turnover amp three-month average impact cost
IndustrySector Representation Scrip selection would generally take into account a
balanced sectorial representation of the listed companies in the universe of BSE
Track Record In the opinion of the BSE Index Committee the company should
have an acceptable track record
210 STOCK MARKET VOLATILITY
2101 Meaning
Volatility is a measure for variation of price of a financial instrument over time
Historic volatility is derived from time series of past market prices An implied
volatility is derived from the market price of a market traded derivative (in particular
an option) Volatility does not measure the direction of price changes merely their
dispersion This is because when calculating standard deviation (or variance) all
differences are squared so that negative and positive differences are combined into
one quantity Two instruments with different volatilities may have the same expected
return but the instrument with higher volatility will have larger swings in values over
a given period of time
For example a lower volatility stock may have an expected (average) return of 7
with annual volatility of 5 This would indicate returns from approximately negative
3 to positive 17 most of the time (19 times out of 20 or 95 via a two standard
deviation rule) A higher volatility stock with the same expected return of 7 but
with annual volatility of 20 would indicate returns from approximately negative
33 to positive 47 most of the time (19 times out of 20 or 95) These estimates
assume a normal distribution in reality stocks are found to be leptokurtotic
55
2102 Terminology used in volatility
Volatility as described here refers to the actual current volatility of a financial
instrument for a specified period (for example 30 days or 90 days) It is the volatility
of a financial instrument based on historical prices over the specified period with the
last observation the most recent price This phrase is used particularly when it is
wished to distinguish between the actual current volatility of an instrument and
actual historical volatility which refers to the volatility of a financial instrument
over a specified period but with the last observation on a date in the past
actual future volatility which refers to the volatility of a financial instrument
over a specified period starting at the current time and ending at a future date
(normally the expiry date of an options)
historical implied volatility which refers to the implied volatility observed from
historical prices of the financial instrument (normally options)
current implied volatility which refers to the implied volatility observed from
current prices of the financial instrument
future implied volatility which refers to the implied volatility observed from
future prices of the financial instrument
For a financial instrument whose price follows a random walk or wiener process the
width of the distribution increases as time increases This is because there is an
increasing profitability that the instruments price will be farther away from the initial
price as time increases However rather than increase linearly the volatility increases
with the square-root of time as time increases because some fluctuations are expected
to cancel each other out so the most likely deviation after twice the time will not be
twice the distance from zero
2103 Usefulness of volatility for Investors
Investors care about volatility for five reasons
1 The wider the swings in an investments price the harder emotionally it is to
not worry
2 Price volatility of a trading instrument can define position sizing in a portfolio
56
3 When certain cash flows from selling a security are needed at a specific future
date higher volatility means a greater chance of a shortfall
4 Higher volatility of returns while saving for retirement results in a wider
distribution of possible final portfolio values
5 Higher volatility of return when retired gives withdrawals a larger permanent
impact on the portfolios value
6 Price volatility presents opportunities to buy assets cheaply and sell when
overpriced
19
13th century Bruges the sign of a purse (or perhaps three purses) hung on the front of
the house where merchants met
There were people in Pisa Verona Genoa and Florence who also began trading in
government securities during the 14th century This was only possible because these
were independent city states ruled by a council of influential citizens not by a duke
The Dutch later started joint stock companies which let shareholders invest in
business ventures and get a share of their profitsmdashor losses In 1602 the Dutch East
India Company issued the first shares on the Amsterdam Stock Exchange It was the
first company to issue stock and bonds In 1688 the trading of stocks began on a
stock exchange in London
On May 17 1792 twenty-four supply brokers signed the Buttonwood Agreement
outside 68 Wall Street in New York underneath a buttonwood tree On March 8
1817 properties got renamed to New York Stock amp Exchange Board In the 19th
century exchanges got substantiated to trade futures contracts and then choices
contracts generally famous as futures exchanges
222 London Stock Exchange - 1698
London Stock Exchange is arguably the oldest of the worlds major stock exchanges
The London Exchange can trace its history back to 1698 when its founder - John
Casting - began to organize the market in Jonathans Coffee-house via a simple list of
stock and commodity prices Today this exchange lists 3500 companies representing
84 countries
223 New York Stock Exchange - 1792
The New York Stock Exchange or NYSE is arguably the oldest and most well known
of all the American stock markets The NYSE was formed in 1792 when two dozen
stockbrokers from New York City had the idea to organize what was then a
disorganized and chaotic method of stock trading From those humble beginnings the
NYSE has continued to grow and today lists 2800 companies with a total
capitalization of nearly $20 trillion In 2007 a historic merger of equals created the
NYSE Euro next
20
224 Bombay Stock Exchange ndash 1875
The Bombay Exchange also known as Mumbai claims to be the oldest stock
exchange in Asia tracing its history back to 1875 In 2008 nearly 2000000 shares
of stock traded daily on the Bombay Exchange
225 American Stock Exchange - 1849
The American Stock Exchange or Amex is a relatively recent addition to the worlds
stock markets The history of this stock market begins with the Curb Exchange and
the California Gold Rush of 1849 The Amex played an important part in the
financial and business transactions associated with the mining industry in the 19th
century In 1921 the Amex expanded it niche role to include companies that did not
meet the strict standards of the NYSE In 1998 the NASDAQ purchased Amex and it
continues its history of being a niche market player and today specializes in
derivatives and stock options In late 2003 the American Stock Exchange regained
its independence After only six years under the control of NASDAQ The Amex
Membership Corporation completed an agreement to transfer control of the exchange
back to its membership
226 NASDAQ - 1971
Yes weve even included a relatively recent addition in this article on stock market
history And thats because we recognize the importance of this particular exchange
At one time most companies aspired to be traded on the NYSE That changed about
10 years ago and many large companies now trade on the NASDAQ Founded in
1971 the National Association of Securities Dealers Automated Quotation or
NASDAQ was the first stock exchange to recognize the role of electronics in stock
trading
Today stock exchanges operate around the world and they have become highly
regulated institutions Investors wanting to buy and sell shares must do so through a
share broker who pays to own a seat on the exchange Companies with shares traded
on an exchange are said to be listed and they must meet specific criteria which
varies across exchanges Most stock exchanges began as floor exchanges where
21
traders made deals face-to-face The largest stock exchange in the world the New
York Stock Exchange continues to operate this way but most of the worlds
exchanges have now become fully electronic The graphs below show (Chart 21 amp
22) world markets in both 1900 and 2000 and the anomalous growth of
the US market during this time While having 10 market share in 1900 India is
leading stock market but in 2000 market share of India is reduced drastically
Chart 21 Stock Market In 1900
Chart 22 Stock Market In 2000
Source Triumph of the optimists
22
12
254
2
11
10
43
7USA
UK
EUROLAND
JAPAN
SOUTH AFRICA
RASSIA
INDIA
AUSTRIA HUNGARY
LATIN AMERICA
47
8
13
13
211
6USA
UK
EUROLAND
JAPAN
CANADA
OTHER FORM 1900
NEW MARKET
22
23 THE ROLE OF STOCK EXCHANGES
The role of a stock exchange for any country appears to be vitally important For any
countries moving toward economic assimilation of enlistment and proficient
allocation of savings to productive investments stock market play imperative role
This is largely proficient through a sound financial architecture Quite a lot of the
most flourishing evolution economies have achieved stupendous increases in the
savings rate with lends a hand of stock exchanges Stock exchanges are indispensable
to support savings and investment in successful conversion countries Companies
often face Liquidation problems that the banking system is powerless or reluctant to
address With a functioning stock market it becomes easier for these firms to find
sources of capital in both domestic and international capital markets A properly
functioning stock exchange will not only help companies raise capital but also help
individuals and organizations to diversify their holdings With thinly traded markets
liquidity problems discourage participation by these investors in the financial system
As such investors will demand higher risk premiums to compensate for lack of
liquidity Thus the company in need of capital is placed at a disadvantage because
only relatively more expensive credit is available Solving this problem has helped
companies to raise more capital in the most successful transition economies while
failure to do so has constrained growth in some of the more backward states Role of
stock exchanges include the following29
231 Raising capital for businesses
The stock market is one of the most important sources for companies to raise money
This allows businesses to be publicly traded or raise additional capital for expansion
by selling shares of ownership of the company in a public market They encourage
investment by providing places for buyers and sellers to trade securities This
investment in turn enables corporations to obtain funds to expand their businesses30
29 Diamond Peter A (1967) The Role of a Stock Market in a General Equilibrium Model with
Technological Uncertainty American Economic Review 57 (4) 759ndash776
30 Gilson Ronald J Black Bernard S (1998) Venture Capital and the Structure of Capital Markets
Banks Versus Stock Markets Journal of Financial Economics 47 243ndash277
23
Corporations issue new securities in the primary market usually with the help of
investment bankers Company negotiates price and then makes the securities available
for its clients and other investors This is called an initial public offering (IPO)
In this primary market corporations receive the proceeds of stock sales After this
initial offering the securities are bought and sold in the secondary market The
corporation is not usually involved in the trading of its stock in the secondary market
therefore stock exchanges will essentially function as a secondary market By
providing investors the opportunity to trade financial instruments the stock exchanges
support the performance of the primary markets This arrangement makes it easier for
a corporation to raise the funds that they need to build and expand their businesses
Although corporations do not directly benefit from secondary market transactions the
managers of a corporation closely monitor the price of the corporationlsquos stock in
secondary markets Reasons for this concern involves the cost of raising new funds
for further business expansion the perceived strength of a company (and whether it
is vulnerable to a takeover) and of course their options and bonus packages
There are benefits and new obligations that come from raising capital through a public
offering
Benefits
Companylsquos access to capital will increase since you can contact more
potential investors
Company may become more widely known
Company may obtain financing more easily in the future if investor interest in
your company grows enough to sustain a secondary trading market in your
securities
Controlling shareholders such as the companys officers or directors may
have a ready market for their shares which means that they can more easily
sell their interests at retirement for diversification or for some other reason
24
Company may be able to attract and retain more highly qualified personnel if
it can offer stock options bonuses or other incentives with a known market
value
The image of company may be improved
Obligations
Company must continue to keep shareholders informed about the companys
business operations financial condition and management incurring additional
costs and new legal obligations
Company may be liable if you do not fulfill these new legal obligations
Company may lose some flexibility in managing your companys affairs
particularly when shareholders must approve your actions
Company public offering will take time and money to accomplish
232 Mobilizing savings for investment
When people draw their savings and invest in shares it leads to a
more rational allocation of resources because funds which could have been
consumed or kept in idle deposits banks are mobilized and redirected to
promote business activity with benefits for several economic sectors such
as agriculture commerce and industry resulting in stronger economic growth and
higher productivity levels of firms
233 Facilitating company growth
The smooth functioning of all these activities facilitates economic growth in that
lower costs and enterprise risks promote the production of goods and services as well
as employment In this way the financial system contributes to increased prosperity
An important aspect of modern financial markets however including the stock
markets is absolute discretion For example American stock markets see more
unrestrained acceptance of any firm than in smaller markets attention must be given to
25
the foreign Companies view acquisitions as an opportunity to expand product lines
increase distribution channels hedge against volatility increase its market share or
acquire other necessary business assets A takeover bid or a merger agreement
through the stock market is one of the simplest and most common ways for a
company to grow by acquisition or fusion
234 Profit sharing
Both casual and professional stock investors through dividends and stock
price increases that may result in capital gains will share in the wealth of profitable
businesses
235 Corporate governance
By having a wide and varied scope of owners companies generally tend to improve
on their management standards and efficiency in order to satisfy the demands of these
shareholders and the more stringent rules for public corporations imposed by public
stock exchanges and the government Consequently it is alleged that public
companies (companies that are owned by shareholders who are members of the
general public and trade shares on public exchanges) tend to have better management
records than privately-held companies (those companies where shares are not publicly
traded often owned by the company founders andor their families and heirs or
otherwise by a small group of investors) However some well-documented cases are
known where it is alleged that there has been considerable slippage in corporate
governance on the part of some public companies The dot-com bubbles in the early
2000s and the subprime mortgage crisis in 2007-08 are classical examples of
corporate mismanagement Companies like Petscom (2000) Enron
Corporation (2001) OneTel (2001) Sunbeam(2001) Webyan (2001) Adelphia
(2002) MCI World Com (2002) Parmalat (2003) American International Group
(2008) Lehman Brothers (2008) and Satyam Computer Service(2009) were among
the most widely scrutinized by the media
26
236 Creating investment opportunities for small investors
As opposed to other businesses that require huge capital outlay investing in shares is
open to both the large and small stock investors because a person buys the number of
shares they can afford Therefore the Stock Exchange provides the opportunity for
small investors to own shares of the same companies as large investors
The liquidity that an exchange provides affords investors the ability to quickly and
easily sell securities This is an attractive feature of investing in stocks compared to
other less liquid investments such as real estate
237 Government capital-raising for development projects
Governments at various levels may decide to borrow money in order to finance
infrastructure projects such as sewage and water treatment works or housing estates
by selling another category of securities known as bonds These bonds can be raised
through the Stock Exchange whereby members of the public buy them thus loaning
money to the government The issuance of such bonds can obviate the need to directly
tax the citizens in order to finance development although by securing such bonds
with the full faith and credit of the government instead of with collateral the result is
that the government must tax the citizens or otherwise raise additional funds to make
any regular coupon payments and refund the principal when the bonds mature
238 Barometer of the economy
Form the history of many countries it has shown that the price of share and other
assets is an important part of the dynamics of economic activity The price of these
assets can influence or be an up and coming economy Many times the stock market is
considered the primary indicator of a countrylsquos economic development and strength
If the stock market is rising it tends to be associated with increased business and
investments and if the stock market if falling associated with deceased business and
investments It can also be observed that share prices also affect the wealth of
households and their consumption At the stock exchange share price rise or fall may
depending largely on market forces and sentiments When the economy is stable or
growing the share prices tense to raise or remain stable but when economic face
recession depression or financial crisis result in stock market crash Therefore the
27
movement of share prices and in general of the stock indexes can be an indicator of
the general trend in the economy
24 MAJOR STOCK EXCHANGES
Twenty Major Stock Exchanges Of The World Market Capitalization amp Year-to-date
Total Turnover at the end of August 2009
Table 21 Major Stock Exchanges of World
(August 2009 Figure in Million USD) Region Stock Exchange Market Value
Total Share
Turnovers
America Satildeo Paulo Stock Exchange 103251840 36195900
America Toronto Stock Exchange 143287700 79819310
America New York Stock Exchange 1084200190 1215862060
Asia-Pacific Australian Securities Exchange 106651320 56091280
Asia-Pacific Bombay Stock Exchange 108257200 17117620
Asia-Pacific Hong Kong Stock Exchange 194551770 97022760
Asia-Pacific Korea Exchange 72712530 105047380
Asia-Pacific National Stock Exchange of India 101910900 50665230
Asia-Pacific Shanghai Stock Exchange 214275680 331576850
Asia-Pacific Shenzhen Stock Exchange 59632020 170125680
Asia-Pacific Tokyo Stock Exchange 347860250 267598330
Europe Euro next 260509760 119596220
Europe Frankfurt Stock Exchange (Deutsche Boumlrse) 120429200 158973670
Europe London Stock Exchange 256049110 232151850
Europe Madrid Stock Exchange (Bolsas y Mercados
Espantildeoles)
117852560 104075110
Europe Milan Stock Exchange (Borsa Italiana) 63667480 56575930
Europe Nordic Stock Exchange Group OMX1 78114630 50304990
Europe Swiss Exchange 99235640 52086750
Note includes the Copenhagen Helsinki Iceland Stockholm Tallinn Riga and
Vilnius Stock Exchanges
Sources World Federation of Exchanges - Statistics Monthly
Remarks There are 2 pending major mergers NASDAQ with OMX and London
Stock Exchange with Milan Stock Exchange
28
Chart 23 Market Value
Chart 24 Total Share Turnovers
Source From the table 21
000 400000000 800000000 1200000000
Satildeo Paulo Stock Exchange
Toronto Stock ExchangeNew York Stock Exchange
Australian Securities ExchangeBombay Stock Exchange
Hong Kong Stock ExchangeKorea Exchange
National Stock Exchange of India
Shanghai Stock ExchangeShenzhen Stock Exchange
Tokyo Stock ExchangeEuro next
Frankfurt Stock Exchange (Deutsche Boumlrse)
London Stock ExchangeMadrid Stock Exchange (Bolsas y hellip
Milan Stock Exchange (Borsa Italiana)Nordic Stock Exchange Group OMX1
Swiss Exchange Market hellip
000 500000000 1000000000 1500000000
Satildeo Paulo Stock ExchangeToronto Stock Exchange
New York Stock ExchangeAustralian Securities Exchange
Bombay Stock ExchangeHong Kong Stock Exchange
Korea ExchangeNational Stock Exchange of India
Shanghai Stock ExchangeShenzhen Stock Exchange
Tokyo Stock ExchangeEuro next
Frankfurt Stock Exchange (Deutsche hellipLondon Stock Exchange
Madrid Stock Exchange (Bolsas y hellipMilan Stock Exchange (Borsa Italiana)Nordic Stock Exchange Group OMX1
Swiss Exchange Total Share hellip
29
25 REQUIREMENTS BY STOCK EXCHANGE
Companies have to meet the requirements of the exchange in order to have their
stocks and shares listed and traded there but requirements vary by stock exchanges
251 Bombay Stock Exchange
Bombay Stock Exchange (BSE) has requirements for a minimum market
capitalization of Rs250 Million and minimum public float equivalent to Rs100
Million31
252 London Stock Exchange
The main market of the London Stock Exchange has requirements for a minimum
market capitalization (pound700000) three years of audited financial statements
minimum public float (25 per cent) and sufficient working capital for at least 12
months from the date of listing
253 NASDAQ Stock Exchange
To be listed on the NASDAQ a company must have issued at least 125 million shares
of stock worth at least $70 million and must have earned more than $11 million over
the last three years 32
254 New York Stock Exchange
To be listed on the New York Stock Exchange (NYSE) a company must have issued
at least a million shares of stock worth $100 million and must have earned more than
$10 million over the last three years 33
255 Other types of exchanges
In the 19th century exchanges were opened to trade forward
contracts on commodities Exchange traded forward contracts are called futures
contracts These commodity exchanges later started offering future contracts on other
31 wwwbseindiacomaboutabintrobselistsecasp 32 NASDAQ Corporate -NASDAQ Listing Information wwnasdaqcomaboutlisting_informationstm 33 wwwnysecomFramesethtmldisplayPage=listed
30
products such as interest rates and shares as well as Options contracts They are now
generally known as futures exchanges
26 OWNERSHIP
Stock exchanges originated as mutual organizations owned by its member stock
brokers There has been a recent trend for stock exchanges to demutualize where the
members sell their shares in an initial public offering In this way the mutual
organization becomes a corporation with shares that are listed on a stock exchange
Examples are
Australian Securities Exchange (1998) Euro next (merged with New York Stock
Exchange) NASDAQ (2002) The New York Stock Exchange (2005) Bolsas
Mercados Espanoles and the Sao Paulo Stock Exchange (2007) The Shenzhen and
Shanghai stock exchanges can be characterized as quasi-state institutions insofar as
they were created by government bodies in China and their leading personnel are
directly appointed by the China Securities Regulatory Commission
27 HISTORY OF INDIAN STOCK MARKET
The stock exchange in Mumbai is more than 100 years old The origin of the stock
market in India dates back to the end of the eighteenth century when long term
negotiable securities were first issued The real beginning however occurred in the
middle of the nine teeth century after the enactment of the Companies Act in 1850
which introduced the feature of limited liability and generated investor interest in
corporate securities
The Native Share and Stock Brokerslsquo Association now known as the Bombay Stock
Exchange (BSE) was formed in Bombay (now Mumbai) in 1875 This was followed
by the formation of association in Ahmadabad in 1894 Calcutta (now Kolkata) in
1908 and Madras (now Chennai) in 1937 In order to promote the orderly
development of the stock market the central government introduced a comprehensive
legislation called the Securities Contracts (Regulation) Act 1956
31
The Calcutta Stock Exchange (CSE) was the largest stock exchange in India till the
1960s In 1961 there were 1203 listed companies across the various stock exchanges
of the country Of these 576 were listed on the CSE and 297 on the BSE However
during the later half of the 1960s the relative importance of the CSE declined while
that of the BSE increased sharply
One of the oldest stock markets in Asia the Indian Stock Markets have a 200 years
old history
Table 22 Origin of Indian Stock Market
Year Events
18th
Century
East India Company was the dominant institution and by end of the century business in its loan
securities gained full momentum
1830s Business on corporate stocks and shares in Bank and Cotton presses started in Bombay Trading list
by the end of 1839 got broader
1840s Recognition from banks and merchants to about half a dozen brokers
1850s Rapid development of commercial enterprise saw brokerage business attracting more people into
the business
1860s The number of brokers increased to 60
1860-61 The American Civil War broke out which caused a stoppage of cotton supply from United States of
America marking the beginning of the Share Mania in India
1862-63 The number of brokers increased to about 200 to 250
1865 A disastrous slump began at the end of the American Civil War (as an example Bank of Bombay
Share which had touched Rs 2850 could only be sold at Rs 87)
1874 With the rapidly developing share trading business brokers used to gather at a street (now well
known as Dalal Street) for the purpose of transacting business
1875 The Native Share and Stock Brokers Association (also known as The Bombay Stock
Exchange) was established in Bombay
1880s Development of cotton mills industry and set up of many others
1894 Establishment of The Ahmadabad Share and Stock Brokers Association
1880 -
90s
Sharp increase in share prices of jute industries in 1870s was followed by a boom in tea stocks and
coal
1908 The Calcutta Stock Exchange Association was formed
1920 Madras witnessed boom and business at The Madras Stock Exchange was transacted with 100
brokers
1923 When recession followed number of brokers came down to 3 and the Exchange was closed down
32
1934 Establishment of the Lahore Stock Exchange
1936 Merger of the Lahore Stock Exchange with the Punjab Stock Exchange
1937 Re-organization and set up of the Madras Stock Exchange Limited (Pvt) Limited led by
improvement in stock market activities in South India with establishment of new textile mills and
plantation companies
1940 Uttar Pradesh Stock Exchange Limited and Nagpur Stock Exchange Limited was established
1944 Establishment of The Hyderabad Stock Exchange Limited
1947 Delhi Stock and Share Brokers Association Limited and The Delhi Stocks and Shares Exchange
Limited were established and later on merged into The Delhi Stock Exchange Association
Limited
Sources wwwsurfindiacom wwwappuonlinecom
271 Post Independence Scenario
The depression witnessed after the Independence led to closure of a lot of exchanges
in the country Lahore Stock Exchange was closed down after the partition of India
and later on merged with the Delhi Stock Exchange Bangalore Stock Exchange
Limited was registered in 1957 and got recognition only by 1963 Most of the other
Exchanges were in a miserable state till 1957 when they applied for recognition under
Securities Contracts (Regulations) Act 1956 The Exchanges that were recognized
under the Act were
Bombay Calcutta Madras Ahmadabad Delhi Hyderabad Bangalore Indore
272 Many more stock exchanges were established during 1980s
namely
Cochin Stock Exchange (1980)
Uttar Pradesh Stock Exchange Association Limited (at Kanpur 1982)
Pune Stock Exchange Limited (1982)
Ludhiana Stock Exchange Association Limited (1983)
Gauhati Stock Exchange Limited (1984)
Kanara Stock Exchange Limited (at Mangalore 1985)
33
Magadh Stock Exchange Association (at Patna 1986)
Jaipur Stock Exchange Limited (1989)
Bhubaneswar Stock Exchange Association Limited (1989)
Saurashtra Kutch Stock Exchange Limited (at Rajkot 1989)
Vadodara Stock Exchange Limited (at Baroda 1990)
Coimbatore Stock Exchange
Meerut Stock Exchange
At present there are twenty one recognized stock exchanges in India which does not
include the Over The Counter Exchange of India Limited (OTCEI) and the National
Stock Exchange of India Limited (NSEIL)
Government policies during 1980s also played a vital role in the development of the
Indian Stock Markets There was a sharp increase in number of Exchanges listed
companies as well as their capital which is visible from the following table
Table 23 Pattern of Growth of Stock Exchanges
Source SEBI annual report
273 Trading Pattern of the Indian Stock Market
Indian Stock Exchanges allow trading of securities of only those public limited
companies that are listed on the Exchange(s) They are divided into two categories
S
No
As on 31st December 1946 1961 1971 1980 1991 1995 2000 2005
1 No of Stock Exchanges 7 7 8 9 20 22 23 23
2 No of Listed Cos 1125 1203 1599 2265 6229 8593 9413 4731
5 Market value of Capital
of Listed Cos (Cr Rs)
971 1292 2675 6750 110279 478121 6319212 478121
34
Chart 25 Trading Pattern of the Indian Stock Market
Source wwwbseindiacom
274 Types of Transactions
The flowchart below describes the types of transactions that can be carried out on the
Indian stock exchanges
Chart 26 Types of Transactions
Source wwwbseindiacom
Listed Securities of Public limited companies
Specified securities (forward List)
Equity shares of company that are
- Dividend paying
- growth orinted companies
- paid up capital of atleast Rs50 million
- Market capitalisation of atleast Rs100 million
- has more than 20000 shareholders
Non specicied Securities (Cash List)
equity shares of companies not covered in specified securities
Transactions on Indian Stock Exchanges
Spot Delivery Transactions
Forward Transactions
35
Spot Delivery Transactions
Includes transactions that require delivery and payment within stipulated time
period at the time of entering into the contract
This period shall not be more than 14 days following the date of the contract
Forward Transactions
Transactions in which delivery and payment can be extended by further period
of 14 days each
The overall period should not exceed 90 days from the date of contract
Transactions permitted only in case of specified shares
275 Indian stock exchange allows a member broker to perform
following activities
Act as an agent
Buy and sell securities for clients and charge commission for the same
Act as a trader or dealer as a principal
Buy and sell securities on their account and risk
276 Over The Counter Exchange of India (OTCEI)
Traditionally trading in Stock Exchanges in India followed a conventional style
where people used to gather at the Exchange and bids and offers were made by open
outcry This age-old trading mechanism in the Indian stock markets used to create
much functional inefficiency Lack of liquidity and transparency long settlement
periods and benami transactions are a few examples that adversely affected investors
In order to overcome these inefficiencies OTCEI was incorporated in 1990 under the
Companies Act 1956 OTCEI is the first screen based nationwide stock exchange in
India created by Unit Trust of India Industrial Credit and Investment Corporation of
India Industrial Development Bank of India SBI Capital Markets Industrial Finance
Corporation of India General Insurance Corporation and its subsidiaries and Can
Bank Financial Services
36
Chart 27 Securities traded on the OTCEI
Source wwwbseindiacom
Listed Securities
Securities of the companies listed on the OTC
Can be bought or sold at any OTC counter across India
Should not be listed anywhere else
Permitted Securities
Certain securities (Shares and debentures listed on other exchanges)
Unites of Mutual funds can be traded
Initiated Debentures
An equity holding a minimum of one lakh debentures of a particular scrip can
offer them for trading on the OTC
Advantages of OTCEI
Greater liquidity and lesser risk of intermediary charges due to widely spread trading
mechanism across India The screen-based scrip less trading ensures transparency and
accuracy of prices Faster settlement and transfer process as compared to other
exchanges Shorter allotment procedure (in case of a new issue) than other exchanges
277 National Stock Exchange
In order to lift the Indian stock market trading system at par with the international
standards On the basis of the recommendations of high powered Pherwani
Securities teaded on the
OTCEI
Listed Securities
Permitted Securities
Initiated Debentures
37
Committee the National Stock Exchange was incorporated in 1992 by Industrial
Development Bank of India Industrial Credit and Investment Corporation of India
Industrial Finance Corporation of India all Insurance Corporations selected
commercial banks and others
2771 NSE provides exposure to investors in two types of markets
namely
Wholesale debt market
Capital market
Wholesale Debt Market - Similar to money market operations debt market
operations involve institutional investors and corporate bodies entering into
transactions of high value in financial instruments like treasury bills government
securities commercial papers etc
Capital market- A capital market is a market for securities (debt or equity) where
business enterprises and governments can raise long term funds It is defined as a
market in which money is defined as a market in which money is provided for periods
longer than a year34 as the raising of short term funds takes place on other markets
Capital markets may be classified as primary markets and secondary markets In
primary markets new stock or bond issues are sold to investors via a mechanism
known as underwriting In the secondary markets existing securities are sold and
bought among investors or traders usually on a securities exchange over the counter
or elsewhere
278 Trading at NSE amp BSE
Fully automated screen-based trading mechanism
Strictly follows the principle of an order-driven market
Trading members are linked through a communication network
34 Steven M Sheffrin (2003) Economics Principles in action Upper Saddle River Pearson Prentice
Hall
38
This network allows them to execute trade from their offices
The prices at which the buyer and seller are willing to transact will appear on
the screen
When the prices match the transaction will be completed
A confirmation slip will be printed at the office of the trading member
2781 Advantages of trading at NSE amp BSE
Integrated network for trading in stock market of India
Fully automated screen based system that provides higher degree of
transparency
Investors can transact from any part of the country at uniform prices
Greater functional efficiency supported by totally computerized network
28 THE BOMBAY STOCK EXCHANGE
Formerly the Stock Exchange Mumbai popularly called Bombay Stock Exchange
or BSE is the oldest stock exchange in Asia and has the greatest number of listed
companies in the world with 4700 listed as of August 2007 35
It is located at Dalal Street Mumbai India On 31 December 2007 the equity market
capitalization of the BSE was US $ 179 trillion making it the largest stock exchange
in South Asia and the 12th largest in the world
With over 4700 Indian companies list on the stock exchange [10]
and it has a
significant trading volume The BSE SENSEX (SENSITIVE INDEX) also called the
―BSE 30 is a widely used market index in India and Asia Though many other
exchanges exist BSE and the National Stock Exchange of India account for most of
the trading in shares in India
35 World Federation of Exchanges (2007) wwwworld-exchangesorg
39
281 History of the Bombay Stock exchange
Trading in securities has been in vogue in India for a little over 200 years Trading in
securities dates back 1793 most of them being transactions in loan securities of the
East India Company The broking community prospered as there was a rise in prices
which led to a share mania during 1861-65 This bubble burst in 1865 when the
American Civil War ended The brokers realized that investor confidence in the
securities market could be sustained only by organizing themselves into a regulated
body with defined rules and regulations The realization resulted in formation of ―The
Native Share and Stock Brokerslsquo Association which later came to be known as the
Bombay Stock Exchange In 1875 these brokers assembled at a place now called
Dalal Street
The Bombay Stock Exchange is a voluntary nonprofit making association of broker
members It emerged as a premier stock exchange after the 1960 The increased pace
of industrialization caused by the two world wars protection to the domestic industry
and the governmentlsquos fiscal policies aided the growth of new issues which in turn
helped the BSE to prosper The BSE dominated the Indian Capital Market by
accounting for more than 60 per cent of the all Indian turn over
Until 1992 the BSE operated like a closed club of selected members With the
securities scam outburst in 1992 and the SEBI taking over the rains of the Stock
Market the BSE had to bring about changes in its operational policies Until March
1995 the BSE had an open outcry system of trading However when faced with stiff
competition from NSE the countrylsquos first modern computerized and professionally
managed stock exchange set up in 1994 the BSE had to change its system of trading
and operation
On 14 March 1995 the BSE turned to electronic trading whereby brokers trade using
computers This system is known as the BSE On-line Trading System (BOLT)
The introduction of BOLT helped in improving trading volumes significantly
reducing the spread between buy and sell orders better trading in odd lot shares fixed
income instruments and dealings in the renunciation of rights shares
40
In 1995 BOLT was limited to Mumbai whereas the NSE was operating at the
national level As a result the BSE submitted a proposal for allowing installation of
terminals connected to BOLT in centers outside Mumbai After rejecting the proposal
four times on 29 october 1996 the SEBI finally allowed the BSE to use its BOLT
system nationwide Later the BSE set up a central depository system to dematerialize
shares and promote demate Account (trading)
282 Hours of Operation
Beginning of the Day Session 800 to 900
Trading Session 900 to 1530
Position Transfer Session 1530 to 1550
Closing Session 1550 to 1605
Option Exercise Session 1605 to 1635
Margin Session 1635 to 1650
Query Session 1650 to1735
End of Day Session 1735
The hours of operation for the BSE quoted above are stated in terms of the local time
(ie GMT+530) in Mumbai India
BSElsquos normal trading sessions are on all days of the week except Saturdays Sundays
and Holidays declared by the Exchange in advance 36
283 Services of BSE
BSE also had a wide range of services to empower investors and facilitate smooth
transactions These services are as follows
2831 Investor Services
The Dept of investor services redresses grievances of investors BSE was the first
exchange in the country to provide an amount of Rs 1 million towards the investor
36 Asia Technical Analysis with Phil Smith wwwreutersindianet
41
protection fund it is an amount higher than that of any exchange in the country BSE
launched a nationwide investor awareness program ―Safe Investing in the Stock
Market under which 264 programmers were held in more than 200 cities
2832 The BSE Online Trading (BOLT)
BSE on line Trading (BOLT) facilities on-line screen based trading in securities
BOLT is currently operating in 25000 trader work stations located across over 399
cities in India
2833 BSEWEBXcom
In February 2001 BSE introduced the worldlsquos first centralized exchange based
Internet trading system BSEWEBXcom This initiative enables investors anywhere
in the world to trade on BSE platform
2834 Surveillance
BSElsquos Online Surveillance System (BOSS) monitors on a real time basis the price
movements volume position and real time measurements of the default risk market
reconstruct and generation of cross market alerts
2835 BSE Training Institute
BTI imparts capital market training and certification in collaboration with reputed
management institutes and universities It offers over 40 courses on various aspects of
the capital mark and financial sector More than 20000 people have attended the BTI
program
284 Awards
Fowling awards were given to BSE
The world council of Corporate Governance has awarded the Golden Peacock
Global CSR Award for BSElsquos initiatives in corporate social responsibility
The Annual Reports and Accounts of BSE for the year ended March 312006 and
42
March 312007 have been awarded the ICAI awards for excellence in financial
reporting
The Human Resource Management at BSE has won the Asia-Pacific HRM awards
for its efforts in employer branding through talent management at work health
management at work and excellence in HR through technology
Drawing from its rich past and its equally robust performance in the recent times
BSE will continue to remain an icon in the Indian Capital Market
285 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 days closing price is taken for computation of Index closure
The use of Index Closure Algorithm prevents any intentional manipulation of the
closing index value
286 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 affect the
index values The BSE Index Cell does the day-to-day maintenance of the index
within the broad index policy framework set by the BSE Index Committee The BSE
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 BSE Index Committee comprises
of capital market expert fund managers market participants and members of the BSE
Governing Board
43
287 On-Line Computation of the Index
During trading hours value of the Index is calculated and disseminated on real time
basis This is done automatically on the basis of prices at which trades in Index
constituents are executed
288 Adjustment for Bonus Rights and Newly Issued Capital
SENSEX calculation needs to be adjusted for issue of Bonus or 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 BSE Index Cell the base value is adjusted which is used to alter
market capitalization of the component stocks to arrive at the SENSEX value The
BSE Index Cell keeps a close watch on the events that might affect the index on a
regular basis and carries out daily maintenance of all the 19 Indices
2881 Adjustments for Rights Issues
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 (ex-right) price An offsetting or
proportionate adjustment is then made to the Base Market capitalization
2882 Adjustments for Bonus Issue
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
2883 Other Issues 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
buy-back of shares corporate restructuring etc
44
289 Listing Categories
Before badla was resumed in 1996 there were only two categories of securities listed
on the BSE the specified group of shares comprising The securities in which carry
forward deals were allowed and the cash group shares in which no carry forward deals
were permitted Later it was observed that the facility of carry forward was not being
used in all the 94 scrips in the specified group Hence after badla was resumed the
size of the specified group was reduced to 32 scrips on 3 April 1996 The BSE later
decided to regroup the existing A and B group shares into three categories The BSE
delisted 637 companies for a period of 3 years during 2004-05 for non-compliance of
listing agreements
A Group This group consists of large stock with turnover and high floating stock
with large market capitalization In other words scrips with more liquidity and high
networth are included in this group At present there are 150 scrips in this group
B1 Group This group includes scrips of quality companies with equity above Rs 3
crore with high growth potential and trading frequency No carry forward facility was
allowed in this group in June 2000 there were 1803 scrips in this group
B2 Group Scrips in this group were just like those of B1 but with fortnightly
settlement However in September 1996 the BSE introduced weekly settlement for all
scrips listed on the exchange thus doing away with the distinction between the B1 and
B2 groups On June 2000 there were 3219 scrips in this group
Z Group Subsequently a Z group was introduced in 1999 with scrips of companies
that do not meet the rules regulations and stipulations laid down by the exchange It
is a buyer beware company These are some 300 scrips in the group All Z category
stocks result in delivers
F Group A new Flsquo group pertaining to debt market segment was started with effect
from 9 September 1996
S Group The BSE reduced post-public issue capital base requirement from Rs10
crore to Rs3 crore to attract listing by companies with a smaller capital base It also
45
started a new trading segment small cap stock segment known as the Slsquo segment
Corporate with minimum turnover of an equal amount would be eligible to list scrips
on this segment In addition stocks listed on the regional exchanges would also be
able to list on the lsquoSlsquo segment subject to meeting certain criteria
2810 Base Market capitalization Adjustment
The formula for adjusting the Base Market capitalization is as follows
New Base Market Capitalization (NBMC)
New Market capitalization
NBMC = Old Base Market capitalization x mdashmdashmdashmdashmdashmdashmdashmdashmdashmdashmdash
Old Market capitalization
To illustrate suppose a company issues right shares which increases the market
capitalization of the shares of that company by say Rs100 crores The existing Base
Market capitalization (Old Base Market capitalization) say is Rs2450 crores and the
aggregate market capitalization of all the shares included in the index before the right
issue is made is say Rs4781 crore The New Base Market capitalization will then
be
2450x (4781+100)
_____________________ = Rs250124 crores
4781
This figure of Rs 250124 crore will be used as the Base Market capitalization for
calculating the index number from then onwards till the next base change becomes
necessary
Index Review Frequency
The BSE 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
29 STOCK MARKET INDEX
The stock market index is the most important indices of all as it measures overall
market sentiment through a set of stocks that representative of the market The stock
46
market index is a barometer of the market behavior It reflects direction and indicates
day-to-day fluctuations in stock prices The market index reflects expectations about
the behavior of the economy as a whole It is a precursor of economic cycles The
function of a stock index is to provide investors with information regarding the
average share price in the market An ideal index must represent changes in the prices
of the scrips and reflect price movements of typical shares for better market
representation Stock index is a barometer of a nationlsquos economic health as market
prices reflect expectations about the economylsquos performance Stock indices termed as
leading economic as they indicate what is going to happen in the economy in the
future The returns generated in the stock market are based on future expectations A
good market index incorporates a set of scrips which have high market capitalization
and high liquidity Market capitalization is the sum of the market value of all the
stocks included in the index The market value is derived by multiplying the price of
the share outstanding In other words the bid-ask spread is minimum The index on a
day is calculated as the percentage of the aggregate market value of the set of scrips
incorporated in the index on that day to the average market value of the same scrips
during the base period
291 Definition of an Index
A price index is such as the stock market price of the individual securities in the
market It reflects the overall price or return movements of a group of securities
Movements in an index are determined by sample weighting and computational
procedure Sample is normally generated by random selection or try a non random
selection technique designed to incorporate desired characteristics are used to select
sample shares rather than by completely random selection Major criteria for selection
are market activity due representation to various industrial groups and to major stock
exchanges
292 Global Stock Market Indices
2921 The Dow Jones Industrial averagersquos
It is the most widely watched and quoted index because of its long existence The
Dow has 30 constituents and it follows the methodology of price based weighted
47
Changes to stocks included in the Dow are infrequent three stocks were
addeddropped in 1991 four in 1997 and four in 1999 The addition of Microsoft and
Intel in 1999 was the first inclusion of Nasdaq market stocks to the Dow 30
2922 The Nasdaq composite index
The index is the market capitalization weighted of prices for all the stocks listed in the
Nasdaq stock market The Nasdaq composite began on 8 February 1971 with a base
of 100
2923 The Nasdaq 100 index
Nasdaq 100 comprises the largest computer software and telecom stocks by market
capitalization on the Nasdaq For a company to be included in the Nasdaq 100 it must
have a minimum average trading volume of 100000 shares per day and must have
been trading on a major exchange for at least a year or two
2924 The S amp P 500 index
This index comprises 500 biggest publicly traded companies in the US by market
capitalization Most money managers treat the S amp P 500 as a proxy for the US stock
market The S amp P 500 tries to cover all major areas of US economy To be included a
company must be profitable the prospective company must not be closely hold and
must have a large trading volume for its shares
2925 The FTSE 100
The FTSE 100 consists of the largest 100 companies by full market Value listed on
the London Stock Exchange The FTSE 100 is the benchmark index to indicate the
performance of the European market It is a market capitalization weighted index that
also considers the free float weighted of individual stocks before including them in
the index
2926 The MSCI Indices
Include the MSCIEAFE (Europe Australia and Far East) MSCI Europe MSCI
world MSCI (EMF) and MSCI Pacific Basin Indices
48
The MSCI world Index is a free float adjusted market capitalization index that is
designed to measure global developed market equity performance As of April 2002
the MSCI world Index consisted of the MSCI world Index consisted of the following
23 developed market country indices
Australia Austria Belgium Canada Denmark Finland France Germany Greece
Hong Kong Ireland Italy Japan Netherlands New Zealand Norway Singapore
Portugal Spain Sweden Switzerland United Kingdom and the United States of
America
293 Methodology for Calculating The Index
2931 Price Weighted Index
In this method the price of each stock in the index is summed up which is then
equated to an index starting value An arbitrary date is set as the base and the
Laspeyerlsquos Price Index which measures price changes against a fixed base period
quantity weight is used In case of a stock split the market price of the stock falls and
these results in less weighted in the index The Dow Jones Industrial Average and
Nikkie 225 are price-weighted indices
2932 Equal Weighting
In this method each stocklsquos percentage weight in the index is equal and hence all
stocks have an equal influence on the index movement The value line index at
Kansas City Board of Trade (KCBT) is an equal weighted index
2933 Market Capitalization Weighted
29331 Full Market Capitalization Method
In this method the number of shares outstanding multiplied by the market price of a
companylsquos share determines the scriplsquos weighted in the index The shares with the
highest market capitalization would have a higher weighted and would be most
influential in this type of index Eg S amp P 500 Index in USA and S amp P CNX Nify in
India
49
29332 Modified Capitalization Weighted
This method seeks to limit the influence of the largest stocks in the index which
otherwise would dominate the entire index This method sets a limit on the largest
stock or a group of stocks The NASDAQ 100 Index is calculated by using this
method
294 Free Float Market Capitalization Method
2941 Concept
Free float methodology refers to an index construction methodology that takes in to
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 Strategic holding government 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
All BSE indices with exception of BSE-PSU index have adopted the free-float
methodology
2942 Definition of Free Float
Share holding of investor that would not in the normal course come into the
open market for trading are treated as ―Controlling Strategic Holding and
hence not included in free float specifically the following categories of
holding are generally excluded from the definition of free float
Shares hold by foundersdirectorsacquires which has control element
Shares held by person with ―Controlling Interestlsquo
Shares held by Govt as promoters
50
Holding through the FDI Route
Strategic Stakes by private corporate bodiesindividuals
Equity held by employee welfare trusts
Locked-in-shares and shares which not be sold in the open market in normal
course
2943 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-agrave-Vis an investible
index This enables an apple-to-apple comparison thereby facilitating better
evaluation of performance of active managers
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 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
The free float methodology of index construction is considered to be an industry best
practice and all major index providers like MSCI FTSE SampP 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
51
29441 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 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 055 means that only 55 of the market
capitalization of the company will be considered for index calculation
Table 24 Free-float Bands
Free-Float Free-Float Factor Free-Float Free-Float Factor
gt0 - 5 005 gt50 - 55 055
gt5 - 10 010 gt55 - 60 060
gt10 - 15 015 gt60 - 65 065
gt15 - 20 020 gt65 - 70 070
gt20 - 25 025 gt70 - 75 075
gt25 - 30 030 gt75 - 80 080
gt30 - 35 035 gt80 - 85 085
gt35 - 40 040 gt85 - 90 090
gt40 - 45 045 gt90 - 95 095
gt45 - 50 050 gt95 - 100 100
Source wwwbseindiacom
295 BSE Indices
For the premier stock exchange that pioneered the securities transaction business
in India over a century of experience is a proud achievement A lot has changed since
1875 when 318 persons by paying a then princely amount of Re 1 became members
of what today is called Bombay Stock Exchange Limited (BSE) Over the decades
the stock market in the country has passed through good and bad periods The journey
52
in the 20th century has not been an easy one Till the decade of eighties there was no
measure or scale that could precisely measure the various ups and downs in the Indian
stock market BSE in 1986 came out with a Stock Index-SENSEX- that subsequently
became the barometer of the Indian stock market
The launch of SENSEX in 1986 was later followed up in January 1989 by
introduction of BSE National Index (Base 1983-84 = 100) It comprised 100 stocks
listed at five major stock exchanges in India - Mumbai Calcutta Delhi Ahmadabad
and Madras The BSE National Index was renamed BSE-100 Index from October 14
1996 and since then it is being calculated taking into consideration only the prices of
stocks listed at BSE BSE launched the dollar-linked version of BSE-100 index on
May 22 2006
With a view to provide a better representation of the increasing number of listed
companies larger market capitalization and the new industry sectors BSE launched
on 27th May 1994 two new index series viz the BSE-200 and the DOLLEX-200
Since then BSE has come a long way in attuning itself to the varied needs of
investors and market participants In order to fulfill the need for still broader
segment-specific and sector-specific indices BSE has continuously been increasing
the range of its indices BSE-500 Index and 5 sectorial indices were launched in 1999
In 2001 BSE launched BSE-PSU Index DOLLEX-30 and the countrys first free-
float based index - the BSE TEC Index Over the years BSE shifted all its indices to
the free-float methodology
BSE disseminates information on the Price-Earnings Ratio the Price to Book Value
Ratio and the Dividend Yield Percentage on day-to-day basis of all its major indices
The values of all BSE indices are updated on real time basis during market hours and
displayed through the BOLT system BSE website and news wire agencies
All BSE Indices are reviewed periodically by the BSE Index Committee This
Committee which comprises eminent independent finance professionals frames the
broad policy guidelines for the development and maintenance of all BSE indices The
BSE Index Cell carries out the day-to-day maintenance of all indices and conducts
research on development of new indices
53
2951 BSE-100 Index
A broad-based index the BSE-100 was formerly known as the BSE National index
This Index has 1983-84 as the base year and was launched in 1989 In line with the
shift of the BSE Indices to the globally accepted Free-Float methodology BSE-100
was shifted to Free-Float methodology effective from April 5 2004 The method of
computation of Free-Float index and determination of free-float factors is similar to
the methodology for SENSEX
Table 25 Index Specification
Base Year 1983-84
Base Index Value 100
Date of Launch 3-Jan-89
Method of calculation Launched on full market capitalization
method and effective April 05 2004
calculation method shifted to free-float
market capitalization
Number of scrips 100
Index calculation frequency Real Time
Source wwwbseindiacom
2952 Base Year
The financial year 1983-84 has been chosen as the base year The price stability
during that year and proximity to the index series were the main consideration for
choice of 1983-84 as the base year The base value was fixed at 100 points
2953 Dollex-100
BSE also calculates a dollar-linked version of SENSEX and historical values of this
index are available since its inception
2954 BSE-100 index - Scrip Selection Criteria
The general guidelines for selection of constituents in BSE-100 are as follows
Trading Frequency The scrip should have been traded on 95 of the trading days
54
in the last three months Exceptions can be made for extreme reasons like scrip
suspension etc
Final Rank The scrip should figure in the top 200 companies listed by final rank
The final rank is arrived at by assigning 75 weighted to the rank on the basis of
three-month average full market capitalization and 25 weighted to the liquidity rank
based on three-month average daily turnover amp three-month average impact cost
IndustrySector Representation Scrip selection would generally take into account a
balanced sectorial representation of the listed companies in the universe of BSE
Track Record In the opinion of the BSE Index Committee the company should
have an acceptable track record
210 STOCK MARKET VOLATILITY
2101 Meaning
Volatility is a measure for variation of price of a financial instrument over time
Historic volatility is derived from time series of past market prices An implied
volatility is derived from the market price of a market traded derivative (in particular
an option) Volatility does not measure the direction of price changes merely their
dispersion This is because when calculating standard deviation (or variance) all
differences are squared so that negative and positive differences are combined into
one quantity Two instruments with different volatilities may have the same expected
return but the instrument with higher volatility will have larger swings in values over
a given period of time
For example a lower volatility stock may have an expected (average) return of 7
with annual volatility of 5 This would indicate returns from approximately negative
3 to positive 17 most of the time (19 times out of 20 or 95 via a two standard
deviation rule) A higher volatility stock with the same expected return of 7 but
with annual volatility of 20 would indicate returns from approximately negative
33 to positive 47 most of the time (19 times out of 20 or 95) These estimates
assume a normal distribution in reality stocks are found to be leptokurtotic
55
2102 Terminology used in volatility
Volatility as described here refers to the actual current volatility of a financial
instrument for a specified period (for example 30 days or 90 days) It is the volatility
of a financial instrument based on historical prices over the specified period with the
last observation the most recent price This phrase is used particularly when it is
wished to distinguish between the actual current volatility of an instrument and
actual historical volatility which refers to the volatility of a financial instrument
over a specified period but with the last observation on a date in the past
actual future volatility which refers to the volatility of a financial instrument
over a specified period starting at the current time and ending at a future date
(normally the expiry date of an options)
historical implied volatility which refers to the implied volatility observed from
historical prices of the financial instrument (normally options)
current implied volatility which refers to the implied volatility observed from
current prices of the financial instrument
future implied volatility which refers to the implied volatility observed from
future prices of the financial instrument
For a financial instrument whose price follows a random walk or wiener process the
width of the distribution increases as time increases This is because there is an
increasing profitability that the instruments price will be farther away from the initial
price as time increases However rather than increase linearly the volatility increases
with the square-root of time as time increases because some fluctuations are expected
to cancel each other out so the most likely deviation after twice the time will not be
twice the distance from zero
2103 Usefulness of volatility for Investors
Investors care about volatility for five reasons
1 The wider the swings in an investments price the harder emotionally it is to
not worry
2 Price volatility of a trading instrument can define position sizing in a portfolio
56
3 When certain cash flows from selling a security are needed at a specific future
date higher volatility means a greater chance of a shortfall
4 Higher volatility of returns while saving for retirement results in a wider
distribution of possible final portfolio values
5 Higher volatility of return when retired gives withdrawals a larger permanent
impact on the portfolios value
6 Price volatility presents opportunities to buy assets cheaply and sell when
overpriced
20
224 Bombay Stock Exchange ndash 1875
The Bombay Exchange also known as Mumbai claims to be the oldest stock
exchange in Asia tracing its history back to 1875 In 2008 nearly 2000000 shares
of stock traded daily on the Bombay Exchange
225 American Stock Exchange - 1849
The American Stock Exchange or Amex is a relatively recent addition to the worlds
stock markets The history of this stock market begins with the Curb Exchange and
the California Gold Rush of 1849 The Amex played an important part in the
financial and business transactions associated with the mining industry in the 19th
century In 1921 the Amex expanded it niche role to include companies that did not
meet the strict standards of the NYSE In 1998 the NASDAQ purchased Amex and it
continues its history of being a niche market player and today specializes in
derivatives and stock options In late 2003 the American Stock Exchange regained
its independence After only six years under the control of NASDAQ The Amex
Membership Corporation completed an agreement to transfer control of the exchange
back to its membership
226 NASDAQ - 1971
Yes weve even included a relatively recent addition in this article on stock market
history And thats because we recognize the importance of this particular exchange
At one time most companies aspired to be traded on the NYSE That changed about
10 years ago and many large companies now trade on the NASDAQ Founded in
1971 the National Association of Securities Dealers Automated Quotation or
NASDAQ was the first stock exchange to recognize the role of electronics in stock
trading
Today stock exchanges operate around the world and they have become highly
regulated institutions Investors wanting to buy and sell shares must do so through a
share broker who pays to own a seat on the exchange Companies with shares traded
on an exchange are said to be listed and they must meet specific criteria which
varies across exchanges Most stock exchanges began as floor exchanges where
21
traders made deals face-to-face The largest stock exchange in the world the New
York Stock Exchange continues to operate this way but most of the worlds
exchanges have now become fully electronic The graphs below show (Chart 21 amp
22) world markets in both 1900 and 2000 and the anomalous growth of
the US market during this time While having 10 market share in 1900 India is
leading stock market but in 2000 market share of India is reduced drastically
Chart 21 Stock Market In 1900
Chart 22 Stock Market In 2000
Source Triumph of the optimists
22
12
254
2
11
10
43
7USA
UK
EUROLAND
JAPAN
SOUTH AFRICA
RASSIA
INDIA
AUSTRIA HUNGARY
LATIN AMERICA
47
8
13
13
211
6USA
UK
EUROLAND
JAPAN
CANADA
OTHER FORM 1900
NEW MARKET
22
23 THE ROLE OF STOCK EXCHANGES
The role of a stock exchange for any country appears to be vitally important For any
countries moving toward economic assimilation of enlistment and proficient
allocation of savings to productive investments stock market play imperative role
This is largely proficient through a sound financial architecture Quite a lot of the
most flourishing evolution economies have achieved stupendous increases in the
savings rate with lends a hand of stock exchanges Stock exchanges are indispensable
to support savings and investment in successful conversion countries Companies
often face Liquidation problems that the banking system is powerless or reluctant to
address With a functioning stock market it becomes easier for these firms to find
sources of capital in both domestic and international capital markets A properly
functioning stock exchange will not only help companies raise capital but also help
individuals and organizations to diversify their holdings With thinly traded markets
liquidity problems discourage participation by these investors in the financial system
As such investors will demand higher risk premiums to compensate for lack of
liquidity Thus the company in need of capital is placed at a disadvantage because
only relatively more expensive credit is available Solving this problem has helped
companies to raise more capital in the most successful transition economies while
failure to do so has constrained growth in some of the more backward states Role of
stock exchanges include the following29
231 Raising capital for businesses
The stock market is one of the most important sources for companies to raise money
This allows businesses to be publicly traded or raise additional capital for expansion
by selling shares of ownership of the company in a public market They encourage
investment by providing places for buyers and sellers to trade securities This
investment in turn enables corporations to obtain funds to expand their businesses30
29 Diamond Peter A (1967) The Role of a Stock Market in a General Equilibrium Model with
Technological Uncertainty American Economic Review 57 (4) 759ndash776
30 Gilson Ronald J Black Bernard S (1998) Venture Capital and the Structure of Capital Markets
Banks Versus Stock Markets Journal of Financial Economics 47 243ndash277
23
Corporations issue new securities in the primary market usually with the help of
investment bankers Company negotiates price and then makes the securities available
for its clients and other investors This is called an initial public offering (IPO)
In this primary market corporations receive the proceeds of stock sales After this
initial offering the securities are bought and sold in the secondary market The
corporation is not usually involved in the trading of its stock in the secondary market
therefore stock exchanges will essentially function as a secondary market By
providing investors the opportunity to trade financial instruments the stock exchanges
support the performance of the primary markets This arrangement makes it easier for
a corporation to raise the funds that they need to build and expand their businesses
Although corporations do not directly benefit from secondary market transactions the
managers of a corporation closely monitor the price of the corporationlsquos stock in
secondary markets Reasons for this concern involves the cost of raising new funds
for further business expansion the perceived strength of a company (and whether it
is vulnerable to a takeover) and of course their options and bonus packages
There are benefits and new obligations that come from raising capital through a public
offering
Benefits
Companylsquos access to capital will increase since you can contact more
potential investors
Company may become more widely known
Company may obtain financing more easily in the future if investor interest in
your company grows enough to sustain a secondary trading market in your
securities
Controlling shareholders such as the companys officers or directors may
have a ready market for their shares which means that they can more easily
sell their interests at retirement for diversification or for some other reason
24
Company may be able to attract and retain more highly qualified personnel if
it can offer stock options bonuses or other incentives with a known market
value
The image of company may be improved
Obligations
Company must continue to keep shareholders informed about the companys
business operations financial condition and management incurring additional
costs and new legal obligations
Company may be liable if you do not fulfill these new legal obligations
Company may lose some flexibility in managing your companys affairs
particularly when shareholders must approve your actions
Company public offering will take time and money to accomplish
232 Mobilizing savings for investment
When people draw their savings and invest in shares it leads to a
more rational allocation of resources because funds which could have been
consumed or kept in idle deposits banks are mobilized and redirected to
promote business activity with benefits for several economic sectors such
as agriculture commerce and industry resulting in stronger economic growth and
higher productivity levels of firms
233 Facilitating company growth
The smooth functioning of all these activities facilitates economic growth in that
lower costs and enterprise risks promote the production of goods and services as well
as employment In this way the financial system contributes to increased prosperity
An important aspect of modern financial markets however including the stock
markets is absolute discretion For example American stock markets see more
unrestrained acceptance of any firm than in smaller markets attention must be given to
25
the foreign Companies view acquisitions as an opportunity to expand product lines
increase distribution channels hedge against volatility increase its market share or
acquire other necessary business assets A takeover bid or a merger agreement
through the stock market is one of the simplest and most common ways for a
company to grow by acquisition or fusion
234 Profit sharing
Both casual and professional stock investors through dividends and stock
price increases that may result in capital gains will share in the wealth of profitable
businesses
235 Corporate governance
By having a wide and varied scope of owners companies generally tend to improve
on their management standards and efficiency in order to satisfy the demands of these
shareholders and the more stringent rules for public corporations imposed by public
stock exchanges and the government Consequently it is alleged that public
companies (companies that are owned by shareholders who are members of the
general public and trade shares on public exchanges) tend to have better management
records than privately-held companies (those companies where shares are not publicly
traded often owned by the company founders andor their families and heirs or
otherwise by a small group of investors) However some well-documented cases are
known where it is alleged that there has been considerable slippage in corporate
governance on the part of some public companies The dot-com bubbles in the early
2000s and the subprime mortgage crisis in 2007-08 are classical examples of
corporate mismanagement Companies like Petscom (2000) Enron
Corporation (2001) OneTel (2001) Sunbeam(2001) Webyan (2001) Adelphia
(2002) MCI World Com (2002) Parmalat (2003) American International Group
(2008) Lehman Brothers (2008) and Satyam Computer Service(2009) were among
the most widely scrutinized by the media
26
236 Creating investment opportunities for small investors
As opposed to other businesses that require huge capital outlay investing in shares is
open to both the large and small stock investors because a person buys the number of
shares they can afford Therefore the Stock Exchange provides the opportunity for
small investors to own shares of the same companies as large investors
The liquidity that an exchange provides affords investors the ability to quickly and
easily sell securities This is an attractive feature of investing in stocks compared to
other less liquid investments such as real estate
237 Government capital-raising for development projects
Governments at various levels may decide to borrow money in order to finance
infrastructure projects such as sewage and water treatment works or housing estates
by selling another category of securities known as bonds These bonds can be raised
through the Stock Exchange whereby members of the public buy them thus loaning
money to the government The issuance of such bonds can obviate the need to directly
tax the citizens in order to finance development although by securing such bonds
with the full faith and credit of the government instead of with collateral the result is
that the government must tax the citizens or otherwise raise additional funds to make
any regular coupon payments and refund the principal when the bonds mature
238 Barometer of the economy
Form the history of many countries it has shown that the price of share and other
assets is an important part of the dynamics of economic activity The price of these
assets can influence or be an up and coming economy Many times the stock market is
considered the primary indicator of a countrylsquos economic development and strength
If the stock market is rising it tends to be associated with increased business and
investments and if the stock market if falling associated with deceased business and
investments It can also be observed that share prices also affect the wealth of
households and their consumption At the stock exchange share price rise or fall may
depending largely on market forces and sentiments When the economy is stable or
growing the share prices tense to raise or remain stable but when economic face
recession depression or financial crisis result in stock market crash Therefore the
27
movement of share prices and in general of the stock indexes can be an indicator of
the general trend in the economy
24 MAJOR STOCK EXCHANGES
Twenty Major Stock Exchanges Of The World Market Capitalization amp Year-to-date
Total Turnover at the end of August 2009
Table 21 Major Stock Exchanges of World
(August 2009 Figure in Million USD) Region Stock Exchange Market Value
Total Share
Turnovers
America Satildeo Paulo Stock Exchange 103251840 36195900
America Toronto Stock Exchange 143287700 79819310
America New York Stock Exchange 1084200190 1215862060
Asia-Pacific Australian Securities Exchange 106651320 56091280
Asia-Pacific Bombay Stock Exchange 108257200 17117620
Asia-Pacific Hong Kong Stock Exchange 194551770 97022760
Asia-Pacific Korea Exchange 72712530 105047380
Asia-Pacific National Stock Exchange of India 101910900 50665230
Asia-Pacific Shanghai Stock Exchange 214275680 331576850
Asia-Pacific Shenzhen Stock Exchange 59632020 170125680
Asia-Pacific Tokyo Stock Exchange 347860250 267598330
Europe Euro next 260509760 119596220
Europe Frankfurt Stock Exchange (Deutsche Boumlrse) 120429200 158973670
Europe London Stock Exchange 256049110 232151850
Europe Madrid Stock Exchange (Bolsas y Mercados
Espantildeoles)
117852560 104075110
Europe Milan Stock Exchange (Borsa Italiana) 63667480 56575930
Europe Nordic Stock Exchange Group OMX1 78114630 50304990
Europe Swiss Exchange 99235640 52086750
Note includes the Copenhagen Helsinki Iceland Stockholm Tallinn Riga and
Vilnius Stock Exchanges
Sources World Federation of Exchanges - Statistics Monthly
Remarks There are 2 pending major mergers NASDAQ with OMX and London
Stock Exchange with Milan Stock Exchange
28
Chart 23 Market Value
Chart 24 Total Share Turnovers
Source From the table 21
000 400000000 800000000 1200000000
Satildeo Paulo Stock Exchange
Toronto Stock ExchangeNew York Stock Exchange
Australian Securities ExchangeBombay Stock Exchange
Hong Kong Stock ExchangeKorea Exchange
National Stock Exchange of India
Shanghai Stock ExchangeShenzhen Stock Exchange
Tokyo Stock ExchangeEuro next
Frankfurt Stock Exchange (Deutsche Boumlrse)
London Stock ExchangeMadrid Stock Exchange (Bolsas y hellip
Milan Stock Exchange (Borsa Italiana)Nordic Stock Exchange Group OMX1
Swiss Exchange Market hellip
000 500000000 1000000000 1500000000
Satildeo Paulo Stock ExchangeToronto Stock Exchange
New York Stock ExchangeAustralian Securities Exchange
Bombay Stock ExchangeHong Kong Stock Exchange
Korea ExchangeNational Stock Exchange of India
Shanghai Stock ExchangeShenzhen Stock Exchange
Tokyo Stock ExchangeEuro next
Frankfurt Stock Exchange (Deutsche hellipLondon Stock Exchange
Madrid Stock Exchange (Bolsas y hellipMilan Stock Exchange (Borsa Italiana)Nordic Stock Exchange Group OMX1
Swiss Exchange Total Share hellip
29
25 REQUIREMENTS BY STOCK EXCHANGE
Companies have to meet the requirements of the exchange in order to have their
stocks and shares listed and traded there but requirements vary by stock exchanges
251 Bombay Stock Exchange
Bombay Stock Exchange (BSE) has requirements for a minimum market
capitalization of Rs250 Million and minimum public float equivalent to Rs100
Million31
252 London Stock Exchange
The main market of the London Stock Exchange has requirements for a minimum
market capitalization (pound700000) three years of audited financial statements
minimum public float (25 per cent) and sufficient working capital for at least 12
months from the date of listing
253 NASDAQ Stock Exchange
To be listed on the NASDAQ a company must have issued at least 125 million shares
of stock worth at least $70 million and must have earned more than $11 million over
the last three years 32
254 New York Stock Exchange
To be listed on the New York Stock Exchange (NYSE) a company must have issued
at least a million shares of stock worth $100 million and must have earned more than
$10 million over the last three years 33
255 Other types of exchanges
In the 19th century exchanges were opened to trade forward
contracts on commodities Exchange traded forward contracts are called futures
contracts These commodity exchanges later started offering future contracts on other
31 wwwbseindiacomaboutabintrobselistsecasp 32 NASDAQ Corporate -NASDAQ Listing Information wwnasdaqcomaboutlisting_informationstm 33 wwwnysecomFramesethtmldisplayPage=listed
30
products such as interest rates and shares as well as Options contracts They are now
generally known as futures exchanges
26 OWNERSHIP
Stock exchanges originated as mutual organizations owned by its member stock
brokers There has been a recent trend for stock exchanges to demutualize where the
members sell their shares in an initial public offering In this way the mutual
organization becomes a corporation with shares that are listed on a stock exchange
Examples are
Australian Securities Exchange (1998) Euro next (merged with New York Stock
Exchange) NASDAQ (2002) The New York Stock Exchange (2005) Bolsas
Mercados Espanoles and the Sao Paulo Stock Exchange (2007) The Shenzhen and
Shanghai stock exchanges can be characterized as quasi-state institutions insofar as
they were created by government bodies in China and their leading personnel are
directly appointed by the China Securities Regulatory Commission
27 HISTORY OF INDIAN STOCK MARKET
The stock exchange in Mumbai is more than 100 years old The origin of the stock
market in India dates back to the end of the eighteenth century when long term
negotiable securities were first issued The real beginning however occurred in the
middle of the nine teeth century after the enactment of the Companies Act in 1850
which introduced the feature of limited liability and generated investor interest in
corporate securities
The Native Share and Stock Brokerslsquo Association now known as the Bombay Stock
Exchange (BSE) was formed in Bombay (now Mumbai) in 1875 This was followed
by the formation of association in Ahmadabad in 1894 Calcutta (now Kolkata) in
1908 and Madras (now Chennai) in 1937 In order to promote the orderly
development of the stock market the central government introduced a comprehensive
legislation called the Securities Contracts (Regulation) Act 1956
31
The Calcutta Stock Exchange (CSE) was the largest stock exchange in India till the
1960s In 1961 there were 1203 listed companies across the various stock exchanges
of the country Of these 576 were listed on the CSE and 297 on the BSE However
during the later half of the 1960s the relative importance of the CSE declined while
that of the BSE increased sharply
One of the oldest stock markets in Asia the Indian Stock Markets have a 200 years
old history
Table 22 Origin of Indian Stock Market
Year Events
18th
Century
East India Company was the dominant institution and by end of the century business in its loan
securities gained full momentum
1830s Business on corporate stocks and shares in Bank and Cotton presses started in Bombay Trading list
by the end of 1839 got broader
1840s Recognition from banks and merchants to about half a dozen brokers
1850s Rapid development of commercial enterprise saw brokerage business attracting more people into
the business
1860s The number of brokers increased to 60
1860-61 The American Civil War broke out which caused a stoppage of cotton supply from United States of
America marking the beginning of the Share Mania in India
1862-63 The number of brokers increased to about 200 to 250
1865 A disastrous slump began at the end of the American Civil War (as an example Bank of Bombay
Share which had touched Rs 2850 could only be sold at Rs 87)
1874 With the rapidly developing share trading business brokers used to gather at a street (now well
known as Dalal Street) for the purpose of transacting business
1875 The Native Share and Stock Brokers Association (also known as The Bombay Stock
Exchange) was established in Bombay
1880s Development of cotton mills industry and set up of many others
1894 Establishment of The Ahmadabad Share and Stock Brokers Association
1880 -
90s
Sharp increase in share prices of jute industries in 1870s was followed by a boom in tea stocks and
coal
1908 The Calcutta Stock Exchange Association was formed
1920 Madras witnessed boom and business at The Madras Stock Exchange was transacted with 100
brokers
1923 When recession followed number of brokers came down to 3 and the Exchange was closed down
32
1934 Establishment of the Lahore Stock Exchange
1936 Merger of the Lahore Stock Exchange with the Punjab Stock Exchange
1937 Re-organization and set up of the Madras Stock Exchange Limited (Pvt) Limited led by
improvement in stock market activities in South India with establishment of new textile mills and
plantation companies
1940 Uttar Pradesh Stock Exchange Limited and Nagpur Stock Exchange Limited was established
1944 Establishment of The Hyderabad Stock Exchange Limited
1947 Delhi Stock and Share Brokers Association Limited and The Delhi Stocks and Shares Exchange
Limited were established and later on merged into The Delhi Stock Exchange Association
Limited
Sources wwwsurfindiacom wwwappuonlinecom
271 Post Independence Scenario
The depression witnessed after the Independence led to closure of a lot of exchanges
in the country Lahore Stock Exchange was closed down after the partition of India
and later on merged with the Delhi Stock Exchange Bangalore Stock Exchange
Limited was registered in 1957 and got recognition only by 1963 Most of the other
Exchanges were in a miserable state till 1957 when they applied for recognition under
Securities Contracts (Regulations) Act 1956 The Exchanges that were recognized
under the Act were
Bombay Calcutta Madras Ahmadabad Delhi Hyderabad Bangalore Indore
272 Many more stock exchanges were established during 1980s
namely
Cochin Stock Exchange (1980)
Uttar Pradesh Stock Exchange Association Limited (at Kanpur 1982)
Pune Stock Exchange Limited (1982)
Ludhiana Stock Exchange Association Limited (1983)
Gauhati Stock Exchange Limited (1984)
Kanara Stock Exchange Limited (at Mangalore 1985)
33
Magadh Stock Exchange Association (at Patna 1986)
Jaipur Stock Exchange Limited (1989)
Bhubaneswar Stock Exchange Association Limited (1989)
Saurashtra Kutch Stock Exchange Limited (at Rajkot 1989)
Vadodara Stock Exchange Limited (at Baroda 1990)
Coimbatore Stock Exchange
Meerut Stock Exchange
At present there are twenty one recognized stock exchanges in India which does not
include the Over The Counter Exchange of India Limited (OTCEI) and the National
Stock Exchange of India Limited (NSEIL)
Government policies during 1980s also played a vital role in the development of the
Indian Stock Markets There was a sharp increase in number of Exchanges listed
companies as well as their capital which is visible from the following table
Table 23 Pattern of Growth of Stock Exchanges
Source SEBI annual report
273 Trading Pattern of the Indian Stock Market
Indian Stock Exchanges allow trading of securities of only those public limited
companies that are listed on the Exchange(s) They are divided into two categories
S
No
As on 31st December 1946 1961 1971 1980 1991 1995 2000 2005
1 No of Stock Exchanges 7 7 8 9 20 22 23 23
2 No of Listed Cos 1125 1203 1599 2265 6229 8593 9413 4731
5 Market value of Capital
of Listed Cos (Cr Rs)
971 1292 2675 6750 110279 478121 6319212 478121
34
Chart 25 Trading Pattern of the Indian Stock Market
Source wwwbseindiacom
274 Types of Transactions
The flowchart below describes the types of transactions that can be carried out on the
Indian stock exchanges
Chart 26 Types of Transactions
Source wwwbseindiacom
Listed Securities of Public limited companies
Specified securities (forward List)
Equity shares of company that are
- Dividend paying
- growth orinted companies
- paid up capital of atleast Rs50 million
- Market capitalisation of atleast Rs100 million
- has more than 20000 shareholders
Non specicied Securities (Cash List)
equity shares of companies not covered in specified securities
Transactions on Indian Stock Exchanges
Spot Delivery Transactions
Forward Transactions
35
Spot Delivery Transactions
Includes transactions that require delivery and payment within stipulated time
period at the time of entering into the contract
This period shall not be more than 14 days following the date of the contract
Forward Transactions
Transactions in which delivery and payment can be extended by further period
of 14 days each
The overall period should not exceed 90 days from the date of contract
Transactions permitted only in case of specified shares
275 Indian stock exchange allows a member broker to perform
following activities
Act as an agent
Buy and sell securities for clients and charge commission for the same
Act as a trader or dealer as a principal
Buy and sell securities on their account and risk
276 Over The Counter Exchange of India (OTCEI)
Traditionally trading in Stock Exchanges in India followed a conventional style
where people used to gather at the Exchange and bids and offers were made by open
outcry This age-old trading mechanism in the Indian stock markets used to create
much functional inefficiency Lack of liquidity and transparency long settlement
periods and benami transactions are a few examples that adversely affected investors
In order to overcome these inefficiencies OTCEI was incorporated in 1990 under the
Companies Act 1956 OTCEI is the first screen based nationwide stock exchange in
India created by Unit Trust of India Industrial Credit and Investment Corporation of
India Industrial Development Bank of India SBI Capital Markets Industrial Finance
Corporation of India General Insurance Corporation and its subsidiaries and Can
Bank Financial Services
36
Chart 27 Securities traded on the OTCEI
Source wwwbseindiacom
Listed Securities
Securities of the companies listed on the OTC
Can be bought or sold at any OTC counter across India
Should not be listed anywhere else
Permitted Securities
Certain securities (Shares and debentures listed on other exchanges)
Unites of Mutual funds can be traded
Initiated Debentures
An equity holding a minimum of one lakh debentures of a particular scrip can
offer them for trading on the OTC
Advantages of OTCEI
Greater liquidity and lesser risk of intermediary charges due to widely spread trading
mechanism across India The screen-based scrip less trading ensures transparency and
accuracy of prices Faster settlement and transfer process as compared to other
exchanges Shorter allotment procedure (in case of a new issue) than other exchanges
277 National Stock Exchange
In order to lift the Indian stock market trading system at par with the international
standards On the basis of the recommendations of high powered Pherwani
Securities teaded on the
OTCEI
Listed Securities
Permitted Securities
Initiated Debentures
37
Committee the National Stock Exchange was incorporated in 1992 by Industrial
Development Bank of India Industrial Credit and Investment Corporation of India
Industrial Finance Corporation of India all Insurance Corporations selected
commercial banks and others
2771 NSE provides exposure to investors in two types of markets
namely
Wholesale debt market
Capital market
Wholesale Debt Market - Similar to money market operations debt market
operations involve institutional investors and corporate bodies entering into
transactions of high value in financial instruments like treasury bills government
securities commercial papers etc
Capital market- A capital market is a market for securities (debt or equity) where
business enterprises and governments can raise long term funds It is defined as a
market in which money is defined as a market in which money is provided for periods
longer than a year34 as the raising of short term funds takes place on other markets
Capital markets may be classified as primary markets and secondary markets In
primary markets new stock or bond issues are sold to investors via a mechanism
known as underwriting In the secondary markets existing securities are sold and
bought among investors or traders usually on a securities exchange over the counter
or elsewhere
278 Trading at NSE amp BSE
Fully automated screen-based trading mechanism
Strictly follows the principle of an order-driven market
Trading members are linked through a communication network
34 Steven M Sheffrin (2003) Economics Principles in action Upper Saddle River Pearson Prentice
Hall
38
This network allows them to execute trade from their offices
The prices at which the buyer and seller are willing to transact will appear on
the screen
When the prices match the transaction will be completed
A confirmation slip will be printed at the office of the trading member
2781 Advantages of trading at NSE amp BSE
Integrated network for trading in stock market of India
Fully automated screen based system that provides higher degree of
transparency
Investors can transact from any part of the country at uniform prices
Greater functional efficiency supported by totally computerized network
28 THE BOMBAY STOCK EXCHANGE
Formerly the Stock Exchange Mumbai popularly called Bombay Stock Exchange
or BSE is the oldest stock exchange in Asia and has the greatest number of listed
companies in the world with 4700 listed as of August 2007 35
It is located at Dalal Street Mumbai India On 31 December 2007 the equity market
capitalization of the BSE was US $ 179 trillion making it the largest stock exchange
in South Asia and the 12th largest in the world
With over 4700 Indian companies list on the stock exchange [10]
and it has a
significant trading volume The BSE SENSEX (SENSITIVE INDEX) also called the
―BSE 30 is a widely used market index in India and Asia Though many other
exchanges exist BSE and the National Stock Exchange of India account for most of
the trading in shares in India
35 World Federation of Exchanges (2007) wwwworld-exchangesorg
39
281 History of the Bombay Stock exchange
Trading in securities has been in vogue in India for a little over 200 years Trading in
securities dates back 1793 most of them being transactions in loan securities of the
East India Company The broking community prospered as there was a rise in prices
which led to a share mania during 1861-65 This bubble burst in 1865 when the
American Civil War ended The brokers realized that investor confidence in the
securities market could be sustained only by organizing themselves into a regulated
body with defined rules and regulations The realization resulted in formation of ―The
Native Share and Stock Brokerslsquo Association which later came to be known as the
Bombay Stock Exchange In 1875 these brokers assembled at a place now called
Dalal Street
The Bombay Stock Exchange is a voluntary nonprofit making association of broker
members It emerged as a premier stock exchange after the 1960 The increased pace
of industrialization caused by the two world wars protection to the domestic industry
and the governmentlsquos fiscal policies aided the growth of new issues which in turn
helped the BSE to prosper The BSE dominated the Indian Capital Market by
accounting for more than 60 per cent of the all Indian turn over
Until 1992 the BSE operated like a closed club of selected members With the
securities scam outburst in 1992 and the SEBI taking over the rains of the Stock
Market the BSE had to bring about changes in its operational policies Until March
1995 the BSE had an open outcry system of trading However when faced with stiff
competition from NSE the countrylsquos first modern computerized and professionally
managed stock exchange set up in 1994 the BSE had to change its system of trading
and operation
On 14 March 1995 the BSE turned to electronic trading whereby brokers trade using
computers This system is known as the BSE On-line Trading System (BOLT)
The introduction of BOLT helped in improving trading volumes significantly
reducing the spread between buy and sell orders better trading in odd lot shares fixed
income instruments and dealings in the renunciation of rights shares
40
In 1995 BOLT was limited to Mumbai whereas the NSE was operating at the
national level As a result the BSE submitted a proposal for allowing installation of
terminals connected to BOLT in centers outside Mumbai After rejecting the proposal
four times on 29 october 1996 the SEBI finally allowed the BSE to use its BOLT
system nationwide Later the BSE set up a central depository system to dematerialize
shares and promote demate Account (trading)
282 Hours of Operation
Beginning of the Day Session 800 to 900
Trading Session 900 to 1530
Position Transfer Session 1530 to 1550
Closing Session 1550 to 1605
Option Exercise Session 1605 to 1635
Margin Session 1635 to 1650
Query Session 1650 to1735
End of Day Session 1735
The hours of operation for the BSE quoted above are stated in terms of the local time
(ie GMT+530) in Mumbai India
BSElsquos normal trading sessions are on all days of the week except Saturdays Sundays
and Holidays declared by the Exchange in advance 36
283 Services of BSE
BSE also had a wide range of services to empower investors and facilitate smooth
transactions These services are as follows
2831 Investor Services
The Dept of investor services redresses grievances of investors BSE was the first
exchange in the country to provide an amount of Rs 1 million towards the investor
36 Asia Technical Analysis with Phil Smith wwwreutersindianet
41
protection fund it is an amount higher than that of any exchange in the country BSE
launched a nationwide investor awareness program ―Safe Investing in the Stock
Market under which 264 programmers were held in more than 200 cities
2832 The BSE Online Trading (BOLT)
BSE on line Trading (BOLT) facilities on-line screen based trading in securities
BOLT is currently operating in 25000 trader work stations located across over 399
cities in India
2833 BSEWEBXcom
In February 2001 BSE introduced the worldlsquos first centralized exchange based
Internet trading system BSEWEBXcom This initiative enables investors anywhere
in the world to trade on BSE platform
2834 Surveillance
BSElsquos Online Surveillance System (BOSS) monitors on a real time basis the price
movements volume position and real time measurements of the default risk market
reconstruct and generation of cross market alerts
2835 BSE Training Institute
BTI imparts capital market training and certification in collaboration with reputed
management institutes and universities It offers over 40 courses on various aspects of
the capital mark and financial sector More than 20000 people have attended the BTI
program
284 Awards
Fowling awards were given to BSE
The world council of Corporate Governance has awarded the Golden Peacock
Global CSR Award for BSElsquos initiatives in corporate social responsibility
The Annual Reports and Accounts of BSE for the year ended March 312006 and
42
March 312007 have been awarded the ICAI awards for excellence in financial
reporting
The Human Resource Management at BSE has won the Asia-Pacific HRM awards
for its efforts in employer branding through talent management at work health
management at work and excellence in HR through technology
Drawing from its rich past and its equally robust performance in the recent times
BSE will continue to remain an icon in the Indian Capital Market
285 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 days closing price is taken for computation of Index closure
The use of Index Closure Algorithm prevents any intentional manipulation of the
closing index value
286 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 affect the
index values The BSE Index Cell does the day-to-day maintenance of the index
within the broad index policy framework set by the BSE Index Committee The BSE
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 BSE Index Committee comprises
of capital market expert fund managers market participants and members of the BSE
Governing Board
43
287 On-Line Computation of the Index
During trading hours value of the Index is calculated and disseminated on real time
basis This is done automatically on the basis of prices at which trades in Index
constituents are executed
288 Adjustment for Bonus Rights and Newly Issued Capital
SENSEX calculation needs to be adjusted for issue of Bonus or 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 BSE Index Cell the base value is adjusted which is used to alter
market capitalization of the component stocks to arrive at the SENSEX value The
BSE Index Cell keeps a close watch on the events that might affect the index on a
regular basis and carries out daily maintenance of all the 19 Indices
2881 Adjustments for Rights Issues
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 (ex-right) price An offsetting or
proportionate adjustment is then made to the Base Market capitalization
2882 Adjustments for Bonus Issue
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
2883 Other Issues 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
buy-back of shares corporate restructuring etc
44
289 Listing Categories
Before badla was resumed in 1996 there were only two categories of securities listed
on the BSE the specified group of shares comprising The securities in which carry
forward deals were allowed and the cash group shares in which no carry forward deals
were permitted Later it was observed that the facility of carry forward was not being
used in all the 94 scrips in the specified group Hence after badla was resumed the
size of the specified group was reduced to 32 scrips on 3 April 1996 The BSE later
decided to regroup the existing A and B group shares into three categories The BSE
delisted 637 companies for a period of 3 years during 2004-05 for non-compliance of
listing agreements
A Group This group consists of large stock with turnover and high floating stock
with large market capitalization In other words scrips with more liquidity and high
networth are included in this group At present there are 150 scrips in this group
B1 Group This group includes scrips of quality companies with equity above Rs 3
crore with high growth potential and trading frequency No carry forward facility was
allowed in this group in June 2000 there were 1803 scrips in this group
B2 Group Scrips in this group were just like those of B1 but with fortnightly
settlement However in September 1996 the BSE introduced weekly settlement for all
scrips listed on the exchange thus doing away with the distinction between the B1 and
B2 groups On June 2000 there were 3219 scrips in this group
Z Group Subsequently a Z group was introduced in 1999 with scrips of companies
that do not meet the rules regulations and stipulations laid down by the exchange It
is a buyer beware company These are some 300 scrips in the group All Z category
stocks result in delivers
F Group A new Flsquo group pertaining to debt market segment was started with effect
from 9 September 1996
S Group The BSE reduced post-public issue capital base requirement from Rs10
crore to Rs3 crore to attract listing by companies with a smaller capital base It also
45
started a new trading segment small cap stock segment known as the Slsquo segment
Corporate with minimum turnover of an equal amount would be eligible to list scrips
on this segment In addition stocks listed on the regional exchanges would also be
able to list on the lsquoSlsquo segment subject to meeting certain criteria
2810 Base Market capitalization Adjustment
The formula for adjusting the Base Market capitalization is as follows
New Base Market Capitalization (NBMC)
New Market capitalization
NBMC = Old Base Market capitalization x mdashmdashmdashmdashmdashmdashmdashmdashmdashmdashmdash
Old Market capitalization
To illustrate suppose a company issues right shares which increases the market
capitalization of the shares of that company by say Rs100 crores The existing Base
Market capitalization (Old Base Market capitalization) say is Rs2450 crores and the
aggregate market capitalization of all the shares included in the index before the right
issue is made is say Rs4781 crore The New Base Market capitalization will then
be
2450x (4781+100)
_____________________ = Rs250124 crores
4781
This figure of Rs 250124 crore will be used as the Base Market capitalization for
calculating the index number from then onwards till the next base change becomes
necessary
Index Review Frequency
The BSE 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
29 STOCK MARKET INDEX
The stock market index is the most important indices of all as it measures overall
market sentiment through a set of stocks that representative of the market The stock
46
market index is a barometer of the market behavior It reflects direction and indicates
day-to-day fluctuations in stock prices The market index reflects expectations about
the behavior of the economy as a whole It is a precursor of economic cycles The
function of a stock index is to provide investors with information regarding the
average share price in the market An ideal index must represent changes in the prices
of the scrips and reflect price movements of typical shares for better market
representation Stock index is a barometer of a nationlsquos economic health as market
prices reflect expectations about the economylsquos performance Stock indices termed as
leading economic as they indicate what is going to happen in the economy in the
future The returns generated in the stock market are based on future expectations A
good market index incorporates a set of scrips which have high market capitalization
and high liquidity Market capitalization is the sum of the market value of all the
stocks included in the index The market value is derived by multiplying the price of
the share outstanding In other words the bid-ask spread is minimum The index on a
day is calculated as the percentage of the aggregate market value of the set of scrips
incorporated in the index on that day to the average market value of the same scrips
during the base period
291 Definition of an Index
A price index is such as the stock market price of the individual securities in the
market It reflects the overall price or return movements of a group of securities
Movements in an index are determined by sample weighting and computational
procedure Sample is normally generated by random selection or try a non random
selection technique designed to incorporate desired characteristics are used to select
sample shares rather than by completely random selection Major criteria for selection
are market activity due representation to various industrial groups and to major stock
exchanges
292 Global Stock Market Indices
2921 The Dow Jones Industrial averagersquos
It is the most widely watched and quoted index because of its long existence The
Dow has 30 constituents and it follows the methodology of price based weighted
47
Changes to stocks included in the Dow are infrequent three stocks were
addeddropped in 1991 four in 1997 and four in 1999 The addition of Microsoft and
Intel in 1999 was the first inclusion of Nasdaq market stocks to the Dow 30
2922 The Nasdaq composite index
The index is the market capitalization weighted of prices for all the stocks listed in the
Nasdaq stock market The Nasdaq composite began on 8 February 1971 with a base
of 100
2923 The Nasdaq 100 index
Nasdaq 100 comprises the largest computer software and telecom stocks by market
capitalization on the Nasdaq For a company to be included in the Nasdaq 100 it must
have a minimum average trading volume of 100000 shares per day and must have
been trading on a major exchange for at least a year or two
2924 The S amp P 500 index
This index comprises 500 biggest publicly traded companies in the US by market
capitalization Most money managers treat the S amp P 500 as a proxy for the US stock
market The S amp P 500 tries to cover all major areas of US economy To be included a
company must be profitable the prospective company must not be closely hold and
must have a large trading volume for its shares
2925 The FTSE 100
The FTSE 100 consists of the largest 100 companies by full market Value listed on
the London Stock Exchange The FTSE 100 is the benchmark index to indicate the
performance of the European market It is a market capitalization weighted index that
also considers the free float weighted of individual stocks before including them in
the index
2926 The MSCI Indices
Include the MSCIEAFE (Europe Australia and Far East) MSCI Europe MSCI
world MSCI (EMF) and MSCI Pacific Basin Indices
48
The MSCI world Index is a free float adjusted market capitalization index that is
designed to measure global developed market equity performance As of April 2002
the MSCI world Index consisted of the MSCI world Index consisted of the following
23 developed market country indices
Australia Austria Belgium Canada Denmark Finland France Germany Greece
Hong Kong Ireland Italy Japan Netherlands New Zealand Norway Singapore
Portugal Spain Sweden Switzerland United Kingdom and the United States of
America
293 Methodology for Calculating The Index
2931 Price Weighted Index
In this method the price of each stock in the index is summed up which is then
equated to an index starting value An arbitrary date is set as the base and the
Laspeyerlsquos Price Index which measures price changes against a fixed base period
quantity weight is used In case of a stock split the market price of the stock falls and
these results in less weighted in the index The Dow Jones Industrial Average and
Nikkie 225 are price-weighted indices
2932 Equal Weighting
In this method each stocklsquos percentage weight in the index is equal and hence all
stocks have an equal influence on the index movement The value line index at
Kansas City Board of Trade (KCBT) is an equal weighted index
2933 Market Capitalization Weighted
29331 Full Market Capitalization Method
In this method the number of shares outstanding multiplied by the market price of a
companylsquos share determines the scriplsquos weighted in the index The shares with the
highest market capitalization would have a higher weighted and would be most
influential in this type of index Eg S amp P 500 Index in USA and S amp P CNX Nify in
India
49
29332 Modified Capitalization Weighted
This method seeks to limit the influence of the largest stocks in the index which
otherwise would dominate the entire index This method sets a limit on the largest
stock or a group of stocks The NASDAQ 100 Index is calculated by using this
method
294 Free Float Market Capitalization Method
2941 Concept
Free float methodology refers to an index construction methodology that takes in to
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 Strategic holding government 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
All BSE indices with exception of BSE-PSU index have adopted the free-float
methodology
2942 Definition of Free Float
Share holding of investor that would not in the normal course come into the
open market for trading are treated as ―Controlling Strategic Holding and
hence not included in free float specifically the following categories of
holding are generally excluded from the definition of free float
Shares hold by foundersdirectorsacquires which has control element
Shares held by person with ―Controlling Interestlsquo
Shares held by Govt as promoters
50
Holding through the FDI Route
Strategic Stakes by private corporate bodiesindividuals
Equity held by employee welfare trusts
Locked-in-shares and shares which not be sold in the open market in normal
course
2943 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-agrave-Vis an investible
index This enables an apple-to-apple comparison thereby facilitating better
evaluation of performance of active managers
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 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
The free float methodology of index construction is considered to be an industry best
practice and all major index providers like MSCI FTSE SampP 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
51
29441 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 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 055 means that only 55 of the market
capitalization of the company will be considered for index calculation
Table 24 Free-float Bands
Free-Float Free-Float Factor Free-Float Free-Float Factor
gt0 - 5 005 gt50 - 55 055
gt5 - 10 010 gt55 - 60 060
gt10 - 15 015 gt60 - 65 065
gt15 - 20 020 gt65 - 70 070
gt20 - 25 025 gt70 - 75 075
gt25 - 30 030 gt75 - 80 080
gt30 - 35 035 gt80 - 85 085
gt35 - 40 040 gt85 - 90 090
gt40 - 45 045 gt90 - 95 095
gt45 - 50 050 gt95 - 100 100
Source wwwbseindiacom
295 BSE Indices
For the premier stock exchange that pioneered the securities transaction business
in India over a century of experience is a proud achievement A lot has changed since
1875 when 318 persons by paying a then princely amount of Re 1 became members
of what today is called Bombay Stock Exchange Limited (BSE) Over the decades
the stock market in the country has passed through good and bad periods The journey
52
in the 20th century has not been an easy one Till the decade of eighties there was no
measure or scale that could precisely measure the various ups and downs in the Indian
stock market BSE in 1986 came out with a Stock Index-SENSEX- that subsequently
became the barometer of the Indian stock market
The launch of SENSEX in 1986 was later followed up in January 1989 by
introduction of BSE National Index (Base 1983-84 = 100) It comprised 100 stocks
listed at five major stock exchanges in India - Mumbai Calcutta Delhi Ahmadabad
and Madras The BSE National Index was renamed BSE-100 Index from October 14
1996 and since then it is being calculated taking into consideration only the prices of
stocks listed at BSE BSE launched the dollar-linked version of BSE-100 index on
May 22 2006
With a view to provide a better representation of the increasing number of listed
companies larger market capitalization and the new industry sectors BSE launched
on 27th May 1994 two new index series viz the BSE-200 and the DOLLEX-200
Since then BSE has come a long way in attuning itself to the varied needs of
investors and market participants In order to fulfill the need for still broader
segment-specific and sector-specific indices BSE has continuously been increasing
the range of its indices BSE-500 Index and 5 sectorial indices were launched in 1999
In 2001 BSE launched BSE-PSU Index DOLLEX-30 and the countrys first free-
float based index - the BSE TEC Index Over the years BSE shifted all its indices to
the free-float methodology
BSE disseminates information on the Price-Earnings Ratio the Price to Book Value
Ratio and the Dividend Yield Percentage on day-to-day basis of all its major indices
The values of all BSE indices are updated on real time basis during market hours and
displayed through the BOLT system BSE website and news wire agencies
All BSE Indices are reviewed periodically by the BSE Index Committee This
Committee which comprises eminent independent finance professionals frames the
broad policy guidelines for the development and maintenance of all BSE indices The
BSE Index Cell carries out the day-to-day maintenance of all indices and conducts
research on development of new indices
53
2951 BSE-100 Index
A broad-based index the BSE-100 was formerly known as the BSE National index
This Index has 1983-84 as the base year and was launched in 1989 In line with the
shift of the BSE Indices to the globally accepted Free-Float methodology BSE-100
was shifted to Free-Float methodology effective from April 5 2004 The method of
computation of Free-Float index and determination of free-float factors is similar to
the methodology for SENSEX
Table 25 Index Specification
Base Year 1983-84
Base Index Value 100
Date of Launch 3-Jan-89
Method of calculation Launched on full market capitalization
method and effective April 05 2004
calculation method shifted to free-float
market capitalization
Number of scrips 100
Index calculation frequency Real Time
Source wwwbseindiacom
2952 Base Year
The financial year 1983-84 has been chosen as the base year The price stability
during that year and proximity to the index series were the main consideration for
choice of 1983-84 as the base year The base value was fixed at 100 points
2953 Dollex-100
BSE also calculates a dollar-linked version of SENSEX and historical values of this
index are available since its inception
2954 BSE-100 index - Scrip Selection Criteria
The general guidelines for selection of constituents in BSE-100 are as follows
Trading Frequency The scrip should have been traded on 95 of the trading days
54
in the last three months Exceptions can be made for extreme reasons like scrip
suspension etc
Final Rank The scrip should figure in the top 200 companies listed by final rank
The final rank is arrived at by assigning 75 weighted to the rank on the basis of
three-month average full market capitalization and 25 weighted to the liquidity rank
based on three-month average daily turnover amp three-month average impact cost
IndustrySector Representation Scrip selection would generally take into account a
balanced sectorial representation of the listed companies in the universe of BSE
Track Record In the opinion of the BSE Index Committee the company should
have an acceptable track record
210 STOCK MARKET VOLATILITY
2101 Meaning
Volatility is a measure for variation of price of a financial instrument over time
Historic volatility is derived from time series of past market prices An implied
volatility is derived from the market price of a market traded derivative (in particular
an option) Volatility does not measure the direction of price changes merely their
dispersion This is because when calculating standard deviation (or variance) all
differences are squared so that negative and positive differences are combined into
one quantity Two instruments with different volatilities may have the same expected
return but the instrument with higher volatility will have larger swings in values over
a given period of time
For example a lower volatility stock may have an expected (average) return of 7
with annual volatility of 5 This would indicate returns from approximately negative
3 to positive 17 most of the time (19 times out of 20 or 95 via a two standard
deviation rule) A higher volatility stock with the same expected return of 7 but
with annual volatility of 20 would indicate returns from approximately negative
33 to positive 47 most of the time (19 times out of 20 or 95) These estimates
assume a normal distribution in reality stocks are found to be leptokurtotic
55
2102 Terminology used in volatility
Volatility as described here refers to the actual current volatility of a financial
instrument for a specified period (for example 30 days or 90 days) It is the volatility
of a financial instrument based on historical prices over the specified period with the
last observation the most recent price This phrase is used particularly when it is
wished to distinguish between the actual current volatility of an instrument and
actual historical volatility which refers to the volatility of a financial instrument
over a specified period but with the last observation on a date in the past
actual future volatility which refers to the volatility of a financial instrument
over a specified period starting at the current time and ending at a future date
(normally the expiry date of an options)
historical implied volatility which refers to the implied volatility observed from
historical prices of the financial instrument (normally options)
current implied volatility which refers to the implied volatility observed from
current prices of the financial instrument
future implied volatility which refers to the implied volatility observed from
future prices of the financial instrument
For a financial instrument whose price follows a random walk or wiener process the
width of the distribution increases as time increases This is because there is an
increasing profitability that the instruments price will be farther away from the initial
price as time increases However rather than increase linearly the volatility increases
with the square-root of time as time increases because some fluctuations are expected
to cancel each other out so the most likely deviation after twice the time will not be
twice the distance from zero
2103 Usefulness of volatility for Investors
Investors care about volatility for five reasons
1 The wider the swings in an investments price the harder emotionally it is to
not worry
2 Price volatility of a trading instrument can define position sizing in a portfolio
56
3 When certain cash flows from selling a security are needed at a specific future
date higher volatility means a greater chance of a shortfall
4 Higher volatility of returns while saving for retirement results in a wider
distribution of possible final portfolio values
5 Higher volatility of return when retired gives withdrawals a larger permanent
impact on the portfolios value
6 Price volatility presents opportunities to buy assets cheaply and sell when
overpriced
21
traders made deals face-to-face The largest stock exchange in the world the New
York Stock Exchange continues to operate this way but most of the worlds
exchanges have now become fully electronic The graphs below show (Chart 21 amp
22) world markets in both 1900 and 2000 and the anomalous growth of
the US market during this time While having 10 market share in 1900 India is
leading stock market but in 2000 market share of India is reduced drastically
Chart 21 Stock Market In 1900
Chart 22 Stock Market In 2000
Source Triumph of the optimists
22
12
254
2
11
10
43
7USA
UK
EUROLAND
JAPAN
SOUTH AFRICA
RASSIA
INDIA
AUSTRIA HUNGARY
LATIN AMERICA
47
8
13
13
211
6USA
UK
EUROLAND
JAPAN
CANADA
OTHER FORM 1900
NEW MARKET
22
23 THE ROLE OF STOCK EXCHANGES
The role of a stock exchange for any country appears to be vitally important For any
countries moving toward economic assimilation of enlistment and proficient
allocation of savings to productive investments stock market play imperative role
This is largely proficient through a sound financial architecture Quite a lot of the
most flourishing evolution economies have achieved stupendous increases in the
savings rate with lends a hand of stock exchanges Stock exchanges are indispensable
to support savings and investment in successful conversion countries Companies
often face Liquidation problems that the banking system is powerless or reluctant to
address With a functioning stock market it becomes easier for these firms to find
sources of capital in both domestic and international capital markets A properly
functioning stock exchange will not only help companies raise capital but also help
individuals and organizations to diversify their holdings With thinly traded markets
liquidity problems discourage participation by these investors in the financial system
As such investors will demand higher risk premiums to compensate for lack of
liquidity Thus the company in need of capital is placed at a disadvantage because
only relatively more expensive credit is available Solving this problem has helped
companies to raise more capital in the most successful transition economies while
failure to do so has constrained growth in some of the more backward states Role of
stock exchanges include the following29
231 Raising capital for businesses
The stock market is one of the most important sources for companies to raise money
This allows businesses to be publicly traded or raise additional capital for expansion
by selling shares of ownership of the company in a public market They encourage
investment by providing places for buyers and sellers to trade securities This
investment in turn enables corporations to obtain funds to expand their businesses30
29 Diamond Peter A (1967) The Role of a Stock Market in a General Equilibrium Model with
Technological Uncertainty American Economic Review 57 (4) 759ndash776
30 Gilson Ronald J Black Bernard S (1998) Venture Capital and the Structure of Capital Markets
Banks Versus Stock Markets Journal of Financial Economics 47 243ndash277
23
Corporations issue new securities in the primary market usually with the help of
investment bankers Company negotiates price and then makes the securities available
for its clients and other investors This is called an initial public offering (IPO)
In this primary market corporations receive the proceeds of stock sales After this
initial offering the securities are bought and sold in the secondary market The
corporation is not usually involved in the trading of its stock in the secondary market
therefore stock exchanges will essentially function as a secondary market By
providing investors the opportunity to trade financial instruments the stock exchanges
support the performance of the primary markets This arrangement makes it easier for
a corporation to raise the funds that they need to build and expand their businesses
Although corporations do not directly benefit from secondary market transactions the
managers of a corporation closely monitor the price of the corporationlsquos stock in
secondary markets Reasons for this concern involves the cost of raising new funds
for further business expansion the perceived strength of a company (and whether it
is vulnerable to a takeover) and of course their options and bonus packages
There are benefits and new obligations that come from raising capital through a public
offering
Benefits
Companylsquos access to capital will increase since you can contact more
potential investors
Company may become more widely known
Company may obtain financing more easily in the future if investor interest in
your company grows enough to sustain a secondary trading market in your
securities
Controlling shareholders such as the companys officers or directors may
have a ready market for their shares which means that they can more easily
sell their interests at retirement for diversification or for some other reason
24
Company may be able to attract and retain more highly qualified personnel if
it can offer stock options bonuses or other incentives with a known market
value
The image of company may be improved
Obligations
Company must continue to keep shareholders informed about the companys
business operations financial condition and management incurring additional
costs and new legal obligations
Company may be liable if you do not fulfill these new legal obligations
Company may lose some flexibility in managing your companys affairs
particularly when shareholders must approve your actions
Company public offering will take time and money to accomplish
232 Mobilizing savings for investment
When people draw their savings and invest in shares it leads to a
more rational allocation of resources because funds which could have been
consumed or kept in idle deposits banks are mobilized and redirected to
promote business activity with benefits for several economic sectors such
as agriculture commerce and industry resulting in stronger economic growth and
higher productivity levels of firms
233 Facilitating company growth
The smooth functioning of all these activities facilitates economic growth in that
lower costs and enterprise risks promote the production of goods and services as well
as employment In this way the financial system contributes to increased prosperity
An important aspect of modern financial markets however including the stock
markets is absolute discretion For example American stock markets see more
unrestrained acceptance of any firm than in smaller markets attention must be given to
25
the foreign Companies view acquisitions as an opportunity to expand product lines
increase distribution channels hedge against volatility increase its market share or
acquire other necessary business assets A takeover bid or a merger agreement
through the stock market is one of the simplest and most common ways for a
company to grow by acquisition or fusion
234 Profit sharing
Both casual and professional stock investors through dividends and stock
price increases that may result in capital gains will share in the wealth of profitable
businesses
235 Corporate governance
By having a wide and varied scope of owners companies generally tend to improve
on their management standards and efficiency in order to satisfy the demands of these
shareholders and the more stringent rules for public corporations imposed by public
stock exchanges and the government Consequently it is alleged that public
companies (companies that are owned by shareholders who are members of the
general public and trade shares on public exchanges) tend to have better management
records than privately-held companies (those companies where shares are not publicly
traded often owned by the company founders andor their families and heirs or
otherwise by a small group of investors) However some well-documented cases are
known where it is alleged that there has been considerable slippage in corporate
governance on the part of some public companies The dot-com bubbles in the early
2000s and the subprime mortgage crisis in 2007-08 are classical examples of
corporate mismanagement Companies like Petscom (2000) Enron
Corporation (2001) OneTel (2001) Sunbeam(2001) Webyan (2001) Adelphia
(2002) MCI World Com (2002) Parmalat (2003) American International Group
(2008) Lehman Brothers (2008) and Satyam Computer Service(2009) were among
the most widely scrutinized by the media
26
236 Creating investment opportunities for small investors
As opposed to other businesses that require huge capital outlay investing in shares is
open to both the large and small stock investors because a person buys the number of
shares they can afford Therefore the Stock Exchange provides the opportunity for
small investors to own shares of the same companies as large investors
The liquidity that an exchange provides affords investors the ability to quickly and
easily sell securities This is an attractive feature of investing in stocks compared to
other less liquid investments such as real estate
237 Government capital-raising for development projects
Governments at various levels may decide to borrow money in order to finance
infrastructure projects such as sewage and water treatment works or housing estates
by selling another category of securities known as bonds These bonds can be raised
through the Stock Exchange whereby members of the public buy them thus loaning
money to the government The issuance of such bonds can obviate the need to directly
tax the citizens in order to finance development although by securing such bonds
with the full faith and credit of the government instead of with collateral the result is
that the government must tax the citizens or otherwise raise additional funds to make
any regular coupon payments and refund the principal when the bonds mature
238 Barometer of the economy
Form the history of many countries it has shown that the price of share and other
assets is an important part of the dynamics of economic activity The price of these
assets can influence or be an up and coming economy Many times the stock market is
considered the primary indicator of a countrylsquos economic development and strength
If the stock market is rising it tends to be associated with increased business and
investments and if the stock market if falling associated with deceased business and
investments It can also be observed that share prices also affect the wealth of
households and their consumption At the stock exchange share price rise or fall may
depending largely on market forces and sentiments When the economy is stable or
growing the share prices tense to raise or remain stable but when economic face
recession depression or financial crisis result in stock market crash Therefore the
27
movement of share prices and in general of the stock indexes can be an indicator of
the general trend in the economy
24 MAJOR STOCK EXCHANGES
Twenty Major Stock Exchanges Of The World Market Capitalization amp Year-to-date
Total Turnover at the end of August 2009
Table 21 Major Stock Exchanges of World
(August 2009 Figure in Million USD) Region Stock Exchange Market Value
Total Share
Turnovers
America Satildeo Paulo Stock Exchange 103251840 36195900
America Toronto Stock Exchange 143287700 79819310
America New York Stock Exchange 1084200190 1215862060
Asia-Pacific Australian Securities Exchange 106651320 56091280
Asia-Pacific Bombay Stock Exchange 108257200 17117620
Asia-Pacific Hong Kong Stock Exchange 194551770 97022760
Asia-Pacific Korea Exchange 72712530 105047380
Asia-Pacific National Stock Exchange of India 101910900 50665230
Asia-Pacific Shanghai Stock Exchange 214275680 331576850
Asia-Pacific Shenzhen Stock Exchange 59632020 170125680
Asia-Pacific Tokyo Stock Exchange 347860250 267598330
Europe Euro next 260509760 119596220
Europe Frankfurt Stock Exchange (Deutsche Boumlrse) 120429200 158973670
Europe London Stock Exchange 256049110 232151850
Europe Madrid Stock Exchange (Bolsas y Mercados
Espantildeoles)
117852560 104075110
Europe Milan Stock Exchange (Borsa Italiana) 63667480 56575930
Europe Nordic Stock Exchange Group OMX1 78114630 50304990
Europe Swiss Exchange 99235640 52086750
Note includes the Copenhagen Helsinki Iceland Stockholm Tallinn Riga and
Vilnius Stock Exchanges
Sources World Federation of Exchanges - Statistics Monthly
Remarks There are 2 pending major mergers NASDAQ with OMX and London
Stock Exchange with Milan Stock Exchange
28
Chart 23 Market Value
Chart 24 Total Share Turnovers
Source From the table 21
000 400000000 800000000 1200000000
Satildeo Paulo Stock Exchange
Toronto Stock ExchangeNew York Stock Exchange
Australian Securities ExchangeBombay Stock Exchange
Hong Kong Stock ExchangeKorea Exchange
National Stock Exchange of India
Shanghai Stock ExchangeShenzhen Stock Exchange
Tokyo Stock ExchangeEuro next
Frankfurt Stock Exchange (Deutsche Boumlrse)
London Stock ExchangeMadrid Stock Exchange (Bolsas y hellip
Milan Stock Exchange (Borsa Italiana)Nordic Stock Exchange Group OMX1
Swiss Exchange Market hellip
000 500000000 1000000000 1500000000
Satildeo Paulo Stock ExchangeToronto Stock Exchange
New York Stock ExchangeAustralian Securities Exchange
Bombay Stock ExchangeHong Kong Stock Exchange
Korea ExchangeNational Stock Exchange of India
Shanghai Stock ExchangeShenzhen Stock Exchange
Tokyo Stock ExchangeEuro next
Frankfurt Stock Exchange (Deutsche hellipLondon Stock Exchange
Madrid Stock Exchange (Bolsas y hellipMilan Stock Exchange (Borsa Italiana)Nordic Stock Exchange Group OMX1
Swiss Exchange Total Share hellip
29
25 REQUIREMENTS BY STOCK EXCHANGE
Companies have to meet the requirements of the exchange in order to have their
stocks and shares listed and traded there but requirements vary by stock exchanges
251 Bombay Stock Exchange
Bombay Stock Exchange (BSE) has requirements for a minimum market
capitalization of Rs250 Million and minimum public float equivalent to Rs100
Million31
252 London Stock Exchange
The main market of the London Stock Exchange has requirements for a minimum
market capitalization (pound700000) three years of audited financial statements
minimum public float (25 per cent) and sufficient working capital for at least 12
months from the date of listing
253 NASDAQ Stock Exchange
To be listed on the NASDAQ a company must have issued at least 125 million shares
of stock worth at least $70 million and must have earned more than $11 million over
the last three years 32
254 New York Stock Exchange
To be listed on the New York Stock Exchange (NYSE) a company must have issued
at least a million shares of stock worth $100 million and must have earned more than
$10 million over the last three years 33
255 Other types of exchanges
In the 19th century exchanges were opened to trade forward
contracts on commodities Exchange traded forward contracts are called futures
contracts These commodity exchanges later started offering future contracts on other
31 wwwbseindiacomaboutabintrobselistsecasp 32 NASDAQ Corporate -NASDAQ Listing Information wwnasdaqcomaboutlisting_informationstm 33 wwwnysecomFramesethtmldisplayPage=listed
30
products such as interest rates and shares as well as Options contracts They are now
generally known as futures exchanges
26 OWNERSHIP
Stock exchanges originated as mutual organizations owned by its member stock
brokers There has been a recent trend for stock exchanges to demutualize where the
members sell their shares in an initial public offering In this way the mutual
organization becomes a corporation with shares that are listed on a stock exchange
Examples are
Australian Securities Exchange (1998) Euro next (merged with New York Stock
Exchange) NASDAQ (2002) The New York Stock Exchange (2005) Bolsas
Mercados Espanoles and the Sao Paulo Stock Exchange (2007) The Shenzhen and
Shanghai stock exchanges can be characterized as quasi-state institutions insofar as
they were created by government bodies in China and their leading personnel are
directly appointed by the China Securities Regulatory Commission
27 HISTORY OF INDIAN STOCK MARKET
The stock exchange in Mumbai is more than 100 years old The origin of the stock
market in India dates back to the end of the eighteenth century when long term
negotiable securities were first issued The real beginning however occurred in the
middle of the nine teeth century after the enactment of the Companies Act in 1850
which introduced the feature of limited liability and generated investor interest in
corporate securities
The Native Share and Stock Brokerslsquo Association now known as the Bombay Stock
Exchange (BSE) was formed in Bombay (now Mumbai) in 1875 This was followed
by the formation of association in Ahmadabad in 1894 Calcutta (now Kolkata) in
1908 and Madras (now Chennai) in 1937 In order to promote the orderly
development of the stock market the central government introduced a comprehensive
legislation called the Securities Contracts (Regulation) Act 1956
31
The Calcutta Stock Exchange (CSE) was the largest stock exchange in India till the
1960s In 1961 there were 1203 listed companies across the various stock exchanges
of the country Of these 576 were listed on the CSE and 297 on the BSE However
during the later half of the 1960s the relative importance of the CSE declined while
that of the BSE increased sharply
One of the oldest stock markets in Asia the Indian Stock Markets have a 200 years
old history
Table 22 Origin of Indian Stock Market
Year Events
18th
Century
East India Company was the dominant institution and by end of the century business in its loan
securities gained full momentum
1830s Business on corporate stocks and shares in Bank and Cotton presses started in Bombay Trading list
by the end of 1839 got broader
1840s Recognition from banks and merchants to about half a dozen brokers
1850s Rapid development of commercial enterprise saw brokerage business attracting more people into
the business
1860s The number of brokers increased to 60
1860-61 The American Civil War broke out which caused a stoppage of cotton supply from United States of
America marking the beginning of the Share Mania in India
1862-63 The number of brokers increased to about 200 to 250
1865 A disastrous slump began at the end of the American Civil War (as an example Bank of Bombay
Share which had touched Rs 2850 could only be sold at Rs 87)
1874 With the rapidly developing share trading business brokers used to gather at a street (now well
known as Dalal Street) for the purpose of transacting business
1875 The Native Share and Stock Brokers Association (also known as The Bombay Stock
Exchange) was established in Bombay
1880s Development of cotton mills industry and set up of many others
1894 Establishment of The Ahmadabad Share and Stock Brokers Association
1880 -
90s
Sharp increase in share prices of jute industries in 1870s was followed by a boom in tea stocks and
coal
1908 The Calcutta Stock Exchange Association was formed
1920 Madras witnessed boom and business at The Madras Stock Exchange was transacted with 100
brokers
1923 When recession followed number of brokers came down to 3 and the Exchange was closed down
32
1934 Establishment of the Lahore Stock Exchange
1936 Merger of the Lahore Stock Exchange with the Punjab Stock Exchange
1937 Re-organization and set up of the Madras Stock Exchange Limited (Pvt) Limited led by
improvement in stock market activities in South India with establishment of new textile mills and
plantation companies
1940 Uttar Pradesh Stock Exchange Limited and Nagpur Stock Exchange Limited was established
1944 Establishment of The Hyderabad Stock Exchange Limited
1947 Delhi Stock and Share Brokers Association Limited and The Delhi Stocks and Shares Exchange
Limited were established and later on merged into The Delhi Stock Exchange Association
Limited
Sources wwwsurfindiacom wwwappuonlinecom
271 Post Independence Scenario
The depression witnessed after the Independence led to closure of a lot of exchanges
in the country Lahore Stock Exchange was closed down after the partition of India
and later on merged with the Delhi Stock Exchange Bangalore Stock Exchange
Limited was registered in 1957 and got recognition only by 1963 Most of the other
Exchanges were in a miserable state till 1957 when they applied for recognition under
Securities Contracts (Regulations) Act 1956 The Exchanges that were recognized
under the Act were
Bombay Calcutta Madras Ahmadabad Delhi Hyderabad Bangalore Indore
272 Many more stock exchanges were established during 1980s
namely
Cochin Stock Exchange (1980)
Uttar Pradesh Stock Exchange Association Limited (at Kanpur 1982)
Pune Stock Exchange Limited (1982)
Ludhiana Stock Exchange Association Limited (1983)
Gauhati Stock Exchange Limited (1984)
Kanara Stock Exchange Limited (at Mangalore 1985)
33
Magadh Stock Exchange Association (at Patna 1986)
Jaipur Stock Exchange Limited (1989)
Bhubaneswar Stock Exchange Association Limited (1989)
Saurashtra Kutch Stock Exchange Limited (at Rajkot 1989)
Vadodara Stock Exchange Limited (at Baroda 1990)
Coimbatore Stock Exchange
Meerut Stock Exchange
At present there are twenty one recognized stock exchanges in India which does not
include the Over The Counter Exchange of India Limited (OTCEI) and the National
Stock Exchange of India Limited (NSEIL)
Government policies during 1980s also played a vital role in the development of the
Indian Stock Markets There was a sharp increase in number of Exchanges listed
companies as well as their capital which is visible from the following table
Table 23 Pattern of Growth of Stock Exchanges
Source SEBI annual report
273 Trading Pattern of the Indian Stock Market
Indian Stock Exchanges allow trading of securities of only those public limited
companies that are listed on the Exchange(s) They are divided into two categories
S
No
As on 31st December 1946 1961 1971 1980 1991 1995 2000 2005
1 No of Stock Exchanges 7 7 8 9 20 22 23 23
2 No of Listed Cos 1125 1203 1599 2265 6229 8593 9413 4731
5 Market value of Capital
of Listed Cos (Cr Rs)
971 1292 2675 6750 110279 478121 6319212 478121
34
Chart 25 Trading Pattern of the Indian Stock Market
Source wwwbseindiacom
274 Types of Transactions
The flowchart below describes the types of transactions that can be carried out on the
Indian stock exchanges
Chart 26 Types of Transactions
Source wwwbseindiacom
Listed Securities of Public limited companies
Specified securities (forward List)
Equity shares of company that are
- Dividend paying
- growth orinted companies
- paid up capital of atleast Rs50 million
- Market capitalisation of atleast Rs100 million
- has more than 20000 shareholders
Non specicied Securities (Cash List)
equity shares of companies not covered in specified securities
Transactions on Indian Stock Exchanges
Spot Delivery Transactions
Forward Transactions
35
Spot Delivery Transactions
Includes transactions that require delivery and payment within stipulated time
period at the time of entering into the contract
This period shall not be more than 14 days following the date of the contract
Forward Transactions
Transactions in which delivery and payment can be extended by further period
of 14 days each
The overall period should not exceed 90 days from the date of contract
Transactions permitted only in case of specified shares
275 Indian stock exchange allows a member broker to perform
following activities
Act as an agent
Buy and sell securities for clients and charge commission for the same
Act as a trader or dealer as a principal
Buy and sell securities on their account and risk
276 Over The Counter Exchange of India (OTCEI)
Traditionally trading in Stock Exchanges in India followed a conventional style
where people used to gather at the Exchange and bids and offers were made by open
outcry This age-old trading mechanism in the Indian stock markets used to create
much functional inefficiency Lack of liquidity and transparency long settlement
periods and benami transactions are a few examples that adversely affected investors
In order to overcome these inefficiencies OTCEI was incorporated in 1990 under the
Companies Act 1956 OTCEI is the first screen based nationwide stock exchange in
India created by Unit Trust of India Industrial Credit and Investment Corporation of
India Industrial Development Bank of India SBI Capital Markets Industrial Finance
Corporation of India General Insurance Corporation and its subsidiaries and Can
Bank Financial Services
36
Chart 27 Securities traded on the OTCEI
Source wwwbseindiacom
Listed Securities
Securities of the companies listed on the OTC
Can be bought or sold at any OTC counter across India
Should not be listed anywhere else
Permitted Securities
Certain securities (Shares and debentures listed on other exchanges)
Unites of Mutual funds can be traded
Initiated Debentures
An equity holding a minimum of one lakh debentures of a particular scrip can
offer them for trading on the OTC
Advantages of OTCEI
Greater liquidity and lesser risk of intermediary charges due to widely spread trading
mechanism across India The screen-based scrip less trading ensures transparency and
accuracy of prices Faster settlement and transfer process as compared to other
exchanges Shorter allotment procedure (in case of a new issue) than other exchanges
277 National Stock Exchange
In order to lift the Indian stock market trading system at par with the international
standards On the basis of the recommendations of high powered Pherwani
Securities teaded on the
OTCEI
Listed Securities
Permitted Securities
Initiated Debentures
37
Committee the National Stock Exchange was incorporated in 1992 by Industrial
Development Bank of India Industrial Credit and Investment Corporation of India
Industrial Finance Corporation of India all Insurance Corporations selected
commercial banks and others
2771 NSE provides exposure to investors in two types of markets
namely
Wholesale debt market
Capital market
Wholesale Debt Market - Similar to money market operations debt market
operations involve institutional investors and corporate bodies entering into
transactions of high value in financial instruments like treasury bills government
securities commercial papers etc
Capital market- A capital market is a market for securities (debt or equity) where
business enterprises and governments can raise long term funds It is defined as a
market in which money is defined as a market in which money is provided for periods
longer than a year34 as the raising of short term funds takes place on other markets
Capital markets may be classified as primary markets and secondary markets In
primary markets new stock or bond issues are sold to investors via a mechanism
known as underwriting In the secondary markets existing securities are sold and
bought among investors or traders usually on a securities exchange over the counter
or elsewhere
278 Trading at NSE amp BSE
Fully automated screen-based trading mechanism
Strictly follows the principle of an order-driven market
Trading members are linked through a communication network
34 Steven M Sheffrin (2003) Economics Principles in action Upper Saddle River Pearson Prentice
Hall
38
This network allows them to execute trade from their offices
The prices at which the buyer and seller are willing to transact will appear on
the screen
When the prices match the transaction will be completed
A confirmation slip will be printed at the office of the trading member
2781 Advantages of trading at NSE amp BSE
Integrated network for trading in stock market of India
Fully automated screen based system that provides higher degree of
transparency
Investors can transact from any part of the country at uniform prices
Greater functional efficiency supported by totally computerized network
28 THE BOMBAY STOCK EXCHANGE
Formerly the Stock Exchange Mumbai popularly called Bombay Stock Exchange
or BSE is the oldest stock exchange in Asia and has the greatest number of listed
companies in the world with 4700 listed as of August 2007 35
It is located at Dalal Street Mumbai India On 31 December 2007 the equity market
capitalization of the BSE was US $ 179 trillion making it the largest stock exchange
in South Asia and the 12th largest in the world
With over 4700 Indian companies list on the stock exchange [10]
and it has a
significant trading volume The BSE SENSEX (SENSITIVE INDEX) also called the
―BSE 30 is a widely used market index in India and Asia Though many other
exchanges exist BSE and the National Stock Exchange of India account for most of
the trading in shares in India
35 World Federation of Exchanges (2007) wwwworld-exchangesorg
39
281 History of the Bombay Stock exchange
Trading in securities has been in vogue in India for a little over 200 years Trading in
securities dates back 1793 most of them being transactions in loan securities of the
East India Company The broking community prospered as there was a rise in prices
which led to a share mania during 1861-65 This bubble burst in 1865 when the
American Civil War ended The brokers realized that investor confidence in the
securities market could be sustained only by organizing themselves into a regulated
body with defined rules and regulations The realization resulted in formation of ―The
Native Share and Stock Brokerslsquo Association which later came to be known as the
Bombay Stock Exchange In 1875 these brokers assembled at a place now called
Dalal Street
The Bombay Stock Exchange is a voluntary nonprofit making association of broker
members It emerged as a premier stock exchange after the 1960 The increased pace
of industrialization caused by the two world wars protection to the domestic industry
and the governmentlsquos fiscal policies aided the growth of new issues which in turn
helped the BSE to prosper The BSE dominated the Indian Capital Market by
accounting for more than 60 per cent of the all Indian turn over
Until 1992 the BSE operated like a closed club of selected members With the
securities scam outburst in 1992 and the SEBI taking over the rains of the Stock
Market the BSE had to bring about changes in its operational policies Until March
1995 the BSE had an open outcry system of trading However when faced with stiff
competition from NSE the countrylsquos first modern computerized and professionally
managed stock exchange set up in 1994 the BSE had to change its system of trading
and operation
On 14 March 1995 the BSE turned to electronic trading whereby brokers trade using
computers This system is known as the BSE On-line Trading System (BOLT)
The introduction of BOLT helped in improving trading volumes significantly
reducing the spread between buy and sell orders better trading in odd lot shares fixed
income instruments and dealings in the renunciation of rights shares
40
In 1995 BOLT was limited to Mumbai whereas the NSE was operating at the
national level As a result the BSE submitted a proposal for allowing installation of
terminals connected to BOLT in centers outside Mumbai After rejecting the proposal
four times on 29 october 1996 the SEBI finally allowed the BSE to use its BOLT
system nationwide Later the BSE set up a central depository system to dematerialize
shares and promote demate Account (trading)
282 Hours of Operation
Beginning of the Day Session 800 to 900
Trading Session 900 to 1530
Position Transfer Session 1530 to 1550
Closing Session 1550 to 1605
Option Exercise Session 1605 to 1635
Margin Session 1635 to 1650
Query Session 1650 to1735
End of Day Session 1735
The hours of operation for the BSE quoted above are stated in terms of the local time
(ie GMT+530) in Mumbai India
BSElsquos normal trading sessions are on all days of the week except Saturdays Sundays
and Holidays declared by the Exchange in advance 36
283 Services of BSE
BSE also had a wide range of services to empower investors and facilitate smooth
transactions These services are as follows
2831 Investor Services
The Dept of investor services redresses grievances of investors BSE was the first
exchange in the country to provide an amount of Rs 1 million towards the investor
36 Asia Technical Analysis with Phil Smith wwwreutersindianet
41
protection fund it is an amount higher than that of any exchange in the country BSE
launched a nationwide investor awareness program ―Safe Investing in the Stock
Market under which 264 programmers were held in more than 200 cities
2832 The BSE Online Trading (BOLT)
BSE on line Trading (BOLT) facilities on-line screen based trading in securities
BOLT is currently operating in 25000 trader work stations located across over 399
cities in India
2833 BSEWEBXcom
In February 2001 BSE introduced the worldlsquos first centralized exchange based
Internet trading system BSEWEBXcom This initiative enables investors anywhere
in the world to trade on BSE platform
2834 Surveillance
BSElsquos Online Surveillance System (BOSS) monitors on a real time basis the price
movements volume position and real time measurements of the default risk market
reconstruct and generation of cross market alerts
2835 BSE Training Institute
BTI imparts capital market training and certification in collaboration with reputed
management institutes and universities It offers over 40 courses on various aspects of
the capital mark and financial sector More than 20000 people have attended the BTI
program
284 Awards
Fowling awards were given to BSE
The world council of Corporate Governance has awarded the Golden Peacock
Global CSR Award for BSElsquos initiatives in corporate social responsibility
The Annual Reports and Accounts of BSE for the year ended March 312006 and
42
March 312007 have been awarded the ICAI awards for excellence in financial
reporting
The Human Resource Management at BSE has won the Asia-Pacific HRM awards
for its efforts in employer branding through talent management at work health
management at work and excellence in HR through technology
Drawing from its rich past and its equally robust performance in the recent times
BSE will continue to remain an icon in the Indian Capital Market
285 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 days closing price is taken for computation of Index closure
The use of Index Closure Algorithm prevents any intentional manipulation of the
closing index value
286 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 affect the
index values The BSE Index Cell does the day-to-day maintenance of the index
within the broad index policy framework set by the BSE Index Committee The BSE
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 BSE Index Committee comprises
of capital market expert fund managers market participants and members of the BSE
Governing Board
43
287 On-Line Computation of the Index
During trading hours value of the Index is calculated and disseminated on real time
basis This is done automatically on the basis of prices at which trades in Index
constituents are executed
288 Adjustment for Bonus Rights and Newly Issued Capital
SENSEX calculation needs to be adjusted for issue of Bonus or 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 BSE Index Cell the base value is adjusted which is used to alter
market capitalization of the component stocks to arrive at the SENSEX value The
BSE Index Cell keeps a close watch on the events that might affect the index on a
regular basis and carries out daily maintenance of all the 19 Indices
2881 Adjustments for Rights Issues
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 (ex-right) price An offsetting or
proportionate adjustment is then made to the Base Market capitalization
2882 Adjustments for Bonus Issue
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
2883 Other Issues 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
buy-back of shares corporate restructuring etc
44
289 Listing Categories
Before badla was resumed in 1996 there were only two categories of securities listed
on the BSE the specified group of shares comprising The securities in which carry
forward deals were allowed and the cash group shares in which no carry forward deals
were permitted Later it was observed that the facility of carry forward was not being
used in all the 94 scrips in the specified group Hence after badla was resumed the
size of the specified group was reduced to 32 scrips on 3 April 1996 The BSE later
decided to regroup the existing A and B group shares into three categories The BSE
delisted 637 companies for a period of 3 years during 2004-05 for non-compliance of
listing agreements
A Group This group consists of large stock with turnover and high floating stock
with large market capitalization In other words scrips with more liquidity and high
networth are included in this group At present there are 150 scrips in this group
B1 Group This group includes scrips of quality companies with equity above Rs 3
crore with high growth potential and trading frequency No carry forward facility was
allowed in this group in June 2000 there were 1803 scrips in this group
B2 Group Scrips in this group were just like those of B1 but with fortnightly
settlement However in September 1996 the BSE introduced weekly settlement for all
scrips listed on the exchange thus doing away with the distinction between the B1 and
B2 groups On June 2000 there were 3219 scrips in this group
Z Group Subsequently a Z group was introduced in 1999 with scrips of companies
that do not meet the rules regulations and stipulations laid down by the exchange It
is a buyer beware company These are some 300 scrips in the group All Z category
stocks result in delivers
F Group A new Flsquo group pertaining to debt market segment was started with effect
from 9 September 1996
S Group The BSE reduced post-public issue capital base requirement from Rs10
crore to Rs3 crore to attract listing by companies with a smaller capital base It also
45
started a new trading segment small cap stock segment known as the Slsquo segment
Corporate with minimum turnover of an equal amount would be eligible to list scrips
on this segment In addition stocks listed on the regional exchanges would also be
able to list on the lsquoSlsquo segment subject to meeting certain criteria
2810 Base Market capitalization Adjustment
The formula for adjusting the Base Market capitalization is as follows
New Base Market Capitalization (NBMC)
New Market capitalization
NBMC = Old Base Market capitalization x mdashmdashmdashmdashmdashmdashmdashmdashmdashmdashmdash
Old Market capitalization
To illustrate suppose a company issues right shares which increases the market
capitalization of the shares of that company by say Rs100 crores The existing Base
Market capitalization (Old Base Market capitalization) say is Rs2450 crores and the
aggregate market capitalization of all the shares included in the index before the right
issue is made is say Rs4781 crore The New Base Market capitalization will then
be
2450x (4781+100)
_____________________ = Rs250124 crores
4781
This figure of Rs 250124 crore will be used as the Base Market capitalization for
calculating the index number from then onwards till the next base change becomes
necessary
Index Review Frequency
The BSE 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
29 STOCK MARKET INDEX
The stock market index is the most important indices of all as it measures overall
market sentiment through a set of stocks that representative of the market The stock
46
market index is a barometer of the market behavior It reflects direction and indicates
day-to-day fluctuations in stock prices The market index reflects expectations about
the behavior of the economy as a whole It is a precursor of economic cycles The
function of a stock index is to provide investors with information regarding the
average share price in the market An ideal index must represent changes in the prices
of the scrips and reflect price movements of typical shares for better market
representation Stock index is a barometer of a nationlsquos economic health as market
prices reflect expectations about the economylsquos performance Stock indices termed as
leading economic as they indicate what is going to happen in the economy in the
future The returns generated in the stock market are based on future expectations A
good market index incorporates a set of scrips which have high market capitalization
and high liquidity Market capitalization is the sum of the market value of all the
stocks included in the index The market value is derived by multiplying the price of
the share outstanding In other words the bid-ask spread is minimum The index on a
day is calculated as the percentage of the aggregate market value of the set of scrips
incorporated in the index on that day to the average market value of the same scrips
during the base period
291 Definition of an Index
A price index is such as the stock market price of the individual securities in the
market It reflects the overall price or return movements of a group of securities
Movements in an index are determined by sample weighting and computational
procedure Sample is normally generated by random selection or try a non random
selection technique designed to incorporate desired characteristics are used to select
sample shares rather than by completely random selection Major criteria for selection
are market activity due representation to various industrial groups and to major stock
exchanges
292 Global Stock Market Indices
2921 The Dow Jones Industrial averagersquos
It is the most widely watched and quoted index because of its long existence The
Dow has 30 constituents and it follows the methodology of price based weighted
47
Changes to stocks included in the Dow are infrequent three stocks were
addeddropped in 1991 four in 1997 and four in 1999 The addition of Microsoft and
Intel in 1999 was the first inclusion of Nasdaq market stocks to the Dow 30
2922 The Nasdaq composite index
The index is the market capitalization weighted of prices for all the stocks listed in the
Nasdaq stock market The Nasdaq composite began on 8 February 1971 with a base
of 100
2923 The Nasdaq 100 index
Nasdaq 100 comprises the largest computer software and telecom stocks by market
capitalization on the Nasdaq For a company to be included in the Nasdaq 100 it must
have a minimum average trading volume of 100000 shares per day and must have
been trading on a major exchange for at least a year or two
2924 The S amp P 500 index
This index comprises 500 biggest publicly traded companies in the US by market
capitalization Most money managers treat the S amp P 500 as a proxy for the US stock
market The S amp P 500 tries to cover all major areas of US economy To be included a
company must be profitable the prospective company must not be closely hold and
must have a large trading volume for its shares
2925 The FTSE 100
The FTSE 100 consists of the largest 100 companies by full market Value listed on
the London Stock Exchange The FTSE 100 is the benchmark index to indicate the
performance of the European market It is a market capitalization weighted index that
also considers the free float weighted of individual stocks before including them in
the index
2926 The MSCI Indices
Include the MSCIEAFE (Europe Australia and Far East) MSCI Europe MSCI
world MSCI (EMF) and MSCI Pacific Basin Indices
48
The MSCI world Index is a free float adjusted market capitalization index that is
designed to measure global developed market equity performance As of April 2002
the MSCI world Index consisted of the MSCI world Index consisted of the following
23 developed market country indices
Australia Austria Belgium Canada Denmark Finland France Germany Greece
Hong Kong Ireland Italy Japan Netherlands New Zealand Norway Singapore
Portugal Spain Sweden Switzerland United Kingdom and the United States of
America
293 Methodology for Calculating The Index
2931 Price Weighted Index
In this method the price of each stock in the index is summed up which is then
equated to an index starting value An arbitrary date is set as the base and the
Laspeyerlsquos Price Index which measures price changes against a fixed base period
quantity weight is used In case of a stock split the market price of the stock falls and
these results in less weighted in the index The Dow Jones Industrial Average and
Nikkie 225 are price-weighted indices
2932 Equal Weighting
In this method each stocklsquos percentage weight in the index is equal and hence all
stocks have an equal influence on the index movement The value line index at
Kansas City Board of Trade (KCBT) is an equal weighted index
2933 Market Capitalization Weighted
29331 Full Market Capitalization Method
In this method the number of shares outstanding multiplied by the market price of a
companylsquos share determines the scriplsquos weighted in the index The shares with the
highest market capitalization would have a higher weighted and would be most
influential in this type of index Eg S amp P 500 Index in USA and S amp P CNX Nify in
India
49
29332 Modified Capitalization Weighted
This method seeks to limit the influence of the largest stocks in the index which
otherwise would dominate the entire index This method sets a limit on the largest
stock or a group of stocks The NASDAQ 100 Index is calculated by using this
method
294 Free Float Market Capitalization Method
2941 Concept
Free float methodology refers to an index construction methodology that takes in to
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 Strategic holding government 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
All BSE indices with exception of BSE-PSU index have adopted the free-float
methodology
2942 Definition of Free Float
Share holding of investor that would not in the normal course come into the
open market for trading are treated as ―Controlling Strategic Holding and
hence not included in free float specifically the following categories of
holding are generally excluded from the definition of free float
Shares hold by foundersdirectorsacquires which has control element
Shares held by person with ―Controlling Interestlsquo
Shares held by Govt as promoters
50
Holding through the FDI Route
Strategic Stakes by private corporate bodiesindividuals
Equity held by employee welfare trusts
Locked-in-shares and shares which not be sold in the open market in normal
course
2943 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-agrave-Vis an investible
index This enables an apple-to-apple comparison thereby facilitating better
evaluation of performance of active managers
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 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
The free float methodology of index construction is considered to be an industry best
practice and all major index providers like MSCI FTSE SampP 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
51
29441 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 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 055 means that only 55 of the market
capitalization of the company will be considered for index calculation
Table 24 Free-float Bands
Free-Float Free-Float Factor Free-Float Free-Float Factor
gt0 - 5 005 gt50 - 55 055
gt5 - 10 010 gt55 - 60 060
gt10 - 15 015 gt60 - 65 065
gt15 - 20 020 gt65 - 70 070
gt20 - 25 025 gt70 - 75 075
gt25 - 30 030 gt75 - 80 080
gt30 - 35 035 gt80 - 85 085
gt35 - 40 040 gt85 - 90 090
gt40 - 45 045 gt90 - 95 095
gt45 - 50 050 gt95 - 100 100
Source wwwbseindiacom
295 BSE Indices
For the premier stock exchange that pioneered the securities transaction business
in India over a century of experience is a proud achievement A lot has changed since
1875 when 318 persons by paying a then princely amount of Re 1 became members
of what today is called Bombay Stock Exchange Limited (BSE) Over the decades
the stock market in the country has passed through good and bad periods The journey
52
in the 20th century has not been an easy one Till the decade of eighties there was no
measure or scale that could precisely measure the various ups and downs in the Indian
stock market BSE in 1986 came out with a Stock Index-SENSEX- that subsequently
became the barometer of the Indian stock market
The launch of SENSEX in 1986 was later followed up in January 1989 by
introduction of BSE National Index (Base 1983-84 = 100) It comprised 100 stocks
listed at five major stock exchanges in India - Mumbai Calcutta Delhi Ahmadabad
and Madras The BSE National Index was renamed BSE-100 Index from October 14
1996 and since then it is being calculated taking into consideration only the prices of
stocks listed at BSE BSE launched the dollar-linked version of BSE-100 index on
May 22 2006
With a view to provide a better representation of the increasing number of listed
companies larger market capitalization and the new industry sectors BSE launched
on 27th May 1994 two new index series viz the BSE-200 and the DOLLEX-200
Since then BSE has come a long way in attuning itself to the varied needs of
investors and market participants In order to fulfill the need for still broader
segment-specific and sector-specific indices BSE has continuously been increasing
the range of its indices BSE-500 Index and 5 sectorial indices were launched in 1999
In 2001 BSE launched BSE-PSU Index DOLLEX-30 and the countrys first free-
float based index - the BSE TEC Index Over the years BSE shifted all its indices to
the free-float methodology
BSE disseminates information on the Price-Earnings Ratio the Price to Book Value
Ratio and the Dividend Yield Percentage on day-to-day basis of all its major indices
The values of all BSE indices are updated on real time basis during market hours and
displayed through the BOLT system BSE website and news wire agencies
All BSE Indices are reviewed periodically by the BSE Index Committee This
Committee which comprises eminent independent finance professionals frames the
broad policy guidelines for the development and maintenance of all BSE indices The
BSE Index Cell carries out the day-to-day maintenance of all indices and conducts
research on development of new indices
53
2951 BSE-100 Index
A broad-based index the BSE-100 was formerly known as the BSE National index
This Index has 1983-84 as the base year and was launched in 1989 In line with the
shift of the BSE Indices to the globally accepted Free-Float methodology BSE-100
was shifted to Free-Float methodology effective from April 5 2004 The method of
computation of Free-Float index and determination of free-float factors is similar to
the methodology for SENSEX
Table 25 Index Specification
Base Year 1983-84
Base Index Value 100
Date of Launch 3-Jan-89
Method of calculation Launched on full market capitalization
method and effective April 05 2004
calculation method shifted to free-float
market capitalization
Number of scrips 100
Index calculation frequency Real Time
Source wwwbseindiacom
2952 Base Year
The financial year 1983-84 has been chosen as the base year The price stability
during that year and proximity to the index series were the main consideration for
choice of 1983-84 as the base year The base value was fixed at 100 points
2953 Dollex-100
BSE also calculates a dollar-linked version of SENSEX and historical values of this
index are available since its inception
2954 BSE-100 index - Scrip Selection Criteria
The general guidelines for selection of constituents in BSE-100 are as follows
Trading Frequency The scrip should have been traded on 95 of the trading days
54
in the last three months Exceptions can be made for extreme reasons like scrip
suspension etc
Final Rank The scrip should figure in the top 200 companies listed by final rank
The final rank is arrived at by assigning 75 weighted to the rank on the basis of
three-month average full market capitalization and 25 weighted to the liquidity rank
based on three-month average daily turnover amp three-month average impact cost
IndustrySector Representation Scrip selection would generally take into account a
balanced sectorial representation of the listed companies in the universe of BSE
Track Record In the opinion of the BSE Index Committee the company should
have an acceptable track record
210 STOCK MARKET VOLATILITY
2101 Meaning
Volatility is a measure for variation of price of a financial instrument over time
Historic volatility is derived from time series of past market prices An implied
volatility is derived from the market price of a market traded derivative (in particular
an option) Volatility does not measure the direction of price changes merely their
dispersion This is because when calculating standard deviation (or variance) all
differences are squared so that negative and positive differences are combined into
one quantity Two instruments with different volatilities may have the same expected
return but the instrument with higher volatility will have larger swings in values over
a given period of time
For example a lower volatility stock may have an expected (average) return of 7
with annual volatility of 5 This would indicate returns from approximately negative
3 to positive 17 most of the time (19 times out of 20 or 95 via a two standard
deviation rule) A higher volatility stock with the same expected return of 7 but
with annual volatility of 20 would indicate returns from approximately negative
33 to positive 47 most of the time (19 times out of 20 or 95) These estimates
assume a normal distribution in reality stocks are found to be leptokurtotic
55
2102 Terminology used in volatility
Volatility as described here refers to the actual current volatility of a financial
instrument for a specified period (for example 30 days or 90 days) It is the volatility
of a financial instrument based on historical prices over the specified period with the
last observation the most recent price This phrase is used particularly when it is
wished to distinguish between the actual current volatility of an instrument and
actual historical volatility which refers to the volatility of a financial instrument
over a specified period but with the last observation on a date in the past
actual future volatility which refers to the volatility of a financial instrument
over a specified period starting at the current time and ending at a future date
(normally the expiry date of an options)
historical implied volatility which refers to the implied volatility observed from
historical prices of the financial instrument (normally options)
current implied volatility which refers to the implied volatility observed from
current prices of the financial instrument
future implied volatility which refers to the implied volatility observed from
future prices of the financial instrument
For a financial instrument whose price follows a random walk or wiener process the
width of the distribution increases as time increases This is because there is an
increasing profitability that the instruments price will be farther away from the initial
price as time increases However rather than increase linearly the volatility increases
with the square-root of time as time increases because some fluctuations are expected
to cancel each other out so the most likely deviation after twice the time will not be
twice the distance from zero
2103 Usefulness of volatility for Investors
Investors care about volatility for five reasons
1 The wider the swings in an investments price the harder emotionally it is to
not worry
2 Price volatility of a trading instrument can define position sizing in a portfolio
56
3 When certain cash flows from selling a security are needed at a specific future
date higher volatility means a greater chance of a shortfall
4 Higher volatility of returns while saving for retirement results in a wider
distribution of possible final portfolio values
5 Higher volatility of return when retired gives withdrawals a larger permanent
impact on the portfolios value
6 Price volatility presents opportunities to buy assets cheaply and sell when
overpriced
22
23 THE ROLE OF STOCK EXCHANGES
The role of a stock exchange for any country appears to be vitally important For any
countries moving toward economic assimilation of enlistment and proficient
allocation of savings to productive investments stock market play imperative role
This is largely proficient through a sound financial architecture Quite a lot of the
most flourishing evolution economies have achieved stupendous increases in the
savings rate with lends a hand of stock exchanges Stock exchanges are indispensable
to support savings and investment in successful conversion countries Companies
often face Liquidation problems that the banking system is powerless or reluctant to
address With a functioning stock market it becomes easier for these firms to find
sources of capital in both domestic and international capital markets A properly
functioning stock exchange will not only help companies raise capital but also help
individuals and organizations to diversify their holdings With thinly traded markets
liquidity problems discourage participation by these investors in the financial system
As such investors will demand higher risk premiums to compensate for lack of
liquidity Thus the company in need of capital is placed at a disadvantage because
only relatively more expensive credit is available Solving this problem has helped
companies to raise more capital in the most successful transition economies while
failure to do so has constrained growth in some of the more backward states Role of
stock exchanges include the following29
231 Raising capital for businesses
The stock market is one of the most important sources for companies to raise money
This allows businesses to be publicly traded or raise additional capital for expansion
by selling shares of ownership of the company in a public market They encourage
investment by providing places for buyers and sellers to trade securities This
investment in turn enables corporations to obtain funds to expand their businesses30
29 Diamond Peter A (1967) The Role of a Stock Market in a General Equilibrium Model with
Technological Uncertainty American Economic Review 57 (4) 759ndash776
30 Gilson Ronald J Black Bernard S (1998) Venture Capital and the Structure of Capital Markets
Banks Versus Stock Markets Journal of Financial Economics 47 243ndash277
23
Corporations issue new securities in the primary market usually with the help of
investment bankers Company negotiates price and then makes the securities available
for its clients and other investors This is called an initial public offering (IPO)
In this primary market corporations receive the proceeds of stock sales After this
initial offering the securities are bought and sold in the secondary market The
corporation is not usually involved in the trading of its stock in the secondary market
therefore stock exchanges will essentially function as a secondary market By
providing investors the opportunity to trade financial instruments the stock exchanges
support the performance of the primary markets This arrangement makes it easier for
a corporation to raise the funds that they need to build and expand their businesses
Although corporations do not directly benefit from secondary market transactions the
managers of a corporation closely monitor the price of the corporationlsquos stock in
secondary markets Reasons for this concern involves the cost of raising new funds
for further business expansion the perceived strength of a company (and whether it
is vulnerable to a takeover) and of course their options and bonus packages
There are benefits and new obligations that come from raising capital through a public
offering
Benefits
Companylsquos access to capital will increase since you can contact more
potential investors
Company may become more widely known
Company may obtain financing more easily in the future if investor interest in
your company grows enough to sustain a secondary trading market in your
securities
Controlling shareholders such as the companys officers or directors may
have a ready market for their shares which means that they can more easily
sell their interests at retirement for diversification or for some other reason
24
Company may be able to attract and retain more highly qualified personnel if
it can offer stock options bonuses or other incentives with a known market
value
The image of company may be improved
Obligations
Company must continue to keep shareholders informed about the companys
business operations financial condition and management incurring additional
costs and new legal obligations
Company may be liable if you do not fulfill these new legal obligations
Company may lose some flexibility in managing your companys affairs
particularly when shareholders must approve your actions
Company public offering will take time and money to accomplish
232 Mobilizing savings for investment
When people draw their savings and invest in shares it leads to a
more rational allocation of resources because funds which could have been
consumed or kept in idle deposits banks are mobilized and redirected to
promote business activity with benefits for several economic sectors such
as agriculture commerce and industry resulting in stronger economic growth and
higher productivity levels of firms
233 Facilitating company growth
The smooth functioning of all these activities facilitates economic growth in that
lower costs and enterprise risks promote the production of goods and services as well
as employment In this way the financial system contributes to increased prosperity
An important aspect of modern financial markets however including the stock
markets is absolute discretion For example American stock markets see more
unrestrained acceptance of any firm than in smaller markets attention must be given to
25
the foreign Companies view acquisitions as an opportunity to expand product lines
increase distribution channels hedge against volatility increase its market share or
acquire other necessary business assets A takeover bid or a merger agreement
through the stock market is one of the simplest and most common ways for a
company to grow by acquisition or fusion
234 Profit sharing
Both casual and professional stock investors through dividends and stock
price increases that may result in capital gains will share in the wealth of profitable
businesses
235 Corporate governance
By having a wide and varied scope of owners companies generally tend to improve
on their management standards and efficiency in order to satisfy the demands of these
shareholders and the more stringent rules for public corporations imposed by public
stock exchanges and the government Consequently it is alleged that public
companies (companies that are owned by shareholders who are members of the
general public and trade shares on public exchanges) tend to have better management
records than privately-held companies (those companies where shares are not publicly
traded often owned by the company founders andor their families and heirs or
otherwise by a small group of investors) However some well-documented cases are
known where it is alleged that there has been considerable slippage in corporate
governance on the part of some public companies The dot-com bubbles in the early
2000s and the subprime mortgage crisis in 2007-08 are classical examples of
corporate mismanagement Companies like Petscom (2000) Enron
Corporation (2001) OneTel (2001) Sunbeam(2001) Webyan (2001) Adelphia
(2002) MCI World Com (2002) Parmalat (2003) American International Group
(2008) Lehman Brothers (2008) and Satyam Computer Service(2009) were among
the most widely scrutinized by the media
26
236 Creating investment opportunities for small investors
As opposed to other businesses that require huge capital outlay investing in shares is
open to both the large and small stock investors because a person buys the number of
shares they can afford Therefore the Stock Exchange provides the opportunity for
small investors to own shares of the same companies as large investors
The liquidity that an exchange provides affords investors the ability to quickly and
easily sell securities This is an attractive feature of investing in stocks compared to
other less liquid investments such as real estate
237 Government capital-raising for development projects
Governments at various levels may decide to borrow money in order to finance
infrastructure projects such as sewage and water treatment works or housing estates
by selling another category of securities known as bonds These bonds can be raised
through the Stock Exchange whereby members of the public buy them thus loaning
money to the government The issuance of such bonds can obviate the need to directly
tax the citizens in order to finance development although by securing such bonds
with the full faith and credit of the government instead of with collateral the result is
that the government must tax the citizens or otherwise raise additional funds to make
any regular coupon payments and refund the principal when the bonds mature
238 Barometer of the economy
Form the history of many countries it has shown that the price of share and other
assets is an important part of the dynamics of economic activity The price of these
assets can influence or be an up and coming economy Many times the stock market is
considered the primary indicator of a countrylsquos economic development and strength
If the stock market is rising it tends to be associated with increased business and
investments and if the stock market if falling associated with deceased business and
investments It can also be observed that share prices also affect the wealth of
households and their consumption At the stock exchange share price rise or fall may
depending largely on market forces and sentiments When the economy is stable or
growing the share prices tense to raise or remain stable but when economic face
recession depression or financial crisis result in stock market crash Therefore the
27
movement of share prices and in general of the stock indexes can be an indicator of
the general trend in the economy
24 MAJOR STOCK EXCHANGES
Twenty Major Stock Exchanges Of The World Market Capitalization amp Year-to-date
Total Turnover at the end of August 2009
Table 21 Major Stock Exchanges of World
(August 2009 Figure in Million USD) Region Stock Exchange Market Value
Total Share
Turnovers
America Satildeo Paulo Stock Exchange 103251840 36195900
America Toronto Stock Exchange 143287700 79819310
America New York Stock Exchange 1084200190 1215862060
Asia-Pacific Australian Securities Exchange 106651320 56091280
Asia-Pacific Bombay Stock Exchange 108257200 17117620
Asia-Pacific Hong Kong Stock Exchange 194551770 97022760
Asia-Pacific Korea Exchange 72712530 105047380
Asia-Pacific National Stock Exchange of India 101910900 50665230
Asia-Pacific Shanghai Stock Exchange 214275680 331576850
Asia-Pacific Shenzhen Stock Exchange 59632020 170125680
Asia-Pacific Tokyo Stock Exchange 347860250 267598330
Europe Euro next 260509760 119596220
Europe Frankfurt Stock Exchange (Deutsche Boumlrse) 120429200 158973670
Europe London Stock Exchange 256049110 232151850
Europe Madrid Stock Exchange (Bolsas y Mercados
Espantildeoles)
117852560 104075110
Europe Milan Stock Exchange (Borsa Italiana) 63667480 56575930
Europe Nordic Stock Exchange Group OMX1 78114630 50304990
Europe Swiss Exchange 99235640 52086750
Note includes the Copenhagen Helsinki Iceland Stockholm Tallinn Riga and
Vilnius Stock Exchanges
Sources World Federation of Exchanges - Statistics Monthly
Remarks There are 2 pending major mergers NASDAQ with OMX and London
Stock Exchange with Milan Stock Exchange
28
Chart 23 Market Value
Chart 24 Total Share Turnovers
Source From the table 21
000 400000000 800000000 1200000000
Satildeo Paulo Stock Exchange
Toronto Stock ExchangeNew York Stock Exchange
Australian Securities ExchangeBombay Stock Exchange
Hong Kong Stock ExchangeKorea Exchange
National Stock Exchange of India
Shanghai Stock ExchangeShenzhen Stock Exchange
Tokyo Stock ExchangeEuro next
Frankfurt Stock Exchange (Deutsche Boumlrse)
London Stock ExchangeMadrid Stock Exchange (Bolsas y hellip
Milan Stock Exchange (Borsa Italiana)Nordic Stock Exchange Group OMX1
Swiss Exchange Market hellip
000 500000000 1000000000 1500000000
Satildeo Paulo Stock ExchangeToronto Stock Exchange
New York Stock ExchangeAustralian Securities Exchange
Bombay Stock ExchangeHong Kong Stock Exchange
Korea ExchangeNational Stock Exchange of India
Shanghai Stock ExchangeShenzhen Stock Exchange
Tokyo Stock ExchangeEuro next
Frankfurt Stock Exchange (Deutsche hellipLondon Stock Exchange
Madrid Stock Exchange (Bolsas y hellipMilan Stock Exchange (Borsa Italiana)Nordic Stock Exchange Group OMX1
Swiss Exchange Total Share hellip
29
25 REQUIREMENTS BY STOCK EXCHANGE
Companies have to meet the requirements of the exchange in order to have their
stocks and shares listed and traded there but requirements vary by stock exchanges
251 Bombay Stock Exchange
Bombay Stock Exchange (BSE) has requirements for a minimum market
capitalization of Rs250 Million and minimum public float equivalent to Rs100
Million31
252 London Stock Exchange
The main market of the London Stock Exchange has requirements for a minimum
market capitalization (pound700000) three years of audited financial statements
minimum public float (25 per cent) and sufficient working capital for at least 12
months from the date of listing
253 NASDAQ Stock Exchange
To be listed on the NASDAQ a company must have issued at least 125 million shares
of stock worth at least $70 million and must have earned more than $11 million over
the last three years 32
254 New York Stock Exchange
To be listed on the New York Stock Exchange (NYSE) a company must have issued
at least a million shares of stock worth $100 million and must have earned more than
$10 million over the last three years 33
255 Other types of exchanges
In the 19th century exchanges were opened to trade forward
contracts on commodities Exchange traded forward contracts are called futures
contracts These commodity exchanges later started offering future contracts on other
31 wwwbseindiacomaboutabintrobselistsecasp 32 NASDAQ Corporate -NASDAQ Listing Information wwnasdaqcomaboutlisting_informationstm 33 wwwnysecomFramesethtmldisplayPage=listed
30
products such as interest rates and shares as well as Options contracts They are now
generally known as futures exchanges
26 OWNERSHIP
Stock exchanges originated as mutual organizations owned by its member stock
brokers There has been a recent trend for stock exchanges to demutualize where the
members sell their shares in an initial public offering In this way the mutual
organization becomes a corporation with shares that are listed on a stock exchange
Examples are
Australian Securities Exchange (1998) Euro next (merged with New York Stock
Exchange) NASDAQ (2002) The New York Stock Exchange (2005) Bolsas
Mercados Espanoles and the Sao Paulo Stock Exchange (2007) The Shenzhen and
Shanghai stock exchanges can be characterized as quasi-state institutions insofar as
they were created by government bodies in China and their leading personnel are
directly appointed by the China Securities Regulatory Commission
27 HISTORY OF INDIAN STOCK MARKET
The stock exchange in Mumbai is more than 100 years old The origin of the stock
market in India dates back to the end of the eighteenth century when long term
negotiable securities were first issued The real beginning however occurred in the
middle of the nine teeth century after the enactment of the Companies Act in 1850
which introduced the feature of limited liability and generated investor interest in
corporate securities
The Native Share and Stock Brokerslsquo Association now known as the Bombay Stock
Exchange (BSE) was formed in Bombay (now Mumbai) in 1875 This was followed
by the formation of association in Ahmadabad in 1894 Calcutta (now Kolkata) in
1908 and Madras (now Chennai) in 1937 In order to promote the orderly
development of the stock market the central government introduced a comprehensive
legislation called the Securities Contracts (Regulation) Act 1956
31
The Calcutta Stock Exchange (CSE) was the largest stock exchange in India till the
1960s In 1961 there were 1203 listed companies across the various stock exchanges
of the country Of these 576 were listed on the CSE and 297 on the BSE However
during the later half of the 1960s the relative importance of the CSE declined while
that of the BSE increased sharply
One of the oldest stock markets in Asia the Indian Stock Markets have a 200 years
old history
Table 22 Origin of Indian Stock Market
Year Events
18th
Century
East India Company was the dominant institution and by end of the century business in its loan
securities gained full momentum
1830s Business on corporate stocks and shares in Bank and Cotton presses started in Bombay Trading list
by the end of 1839 got broader
1840s Recognition from banks and merchants to about half a dozen brokers
1850s Rapid development of commercial enterprise saw brokerage business attracting more people into
the business
1860s The number of brokers increased to 60
1860-61 The American Civil War broke out which caused a stoppage of cotton supply from United States of
America marking the beginning of the Share Mania in India
1862-63 The number of brokers increased to about 200 to 250
1865 A disastrous slump began at the end of the American Civil War (as an example Bank of Bombay
Share which had touched Rs 2850 could only be sold at Rs 87)
1874 With the rapidly developing share trading business brokers used to gather at a street (now well
known as Dalal Street) for the purpose of transacting business
1875 The Native Share and Stock Brokers Association (also known as The Bombay Stock
Exchange) was established in Bombay
1880s Development of cotton mills industry and set up of many others
1894 Establishment of The Ahmadabad Share and Stock Brokers Association
1880 -
90s
Sharp increase in share prices of jute industries in 1870s was followed by a boom in tea stocks and
coal
1908 The Calcutta Stock Exchange Association was formed
1920 Madras witnessed boom and business at The Madras Stock Exchange was transacted with 100
brokers
1923 When recession followed number of brokers came down to 3 and the Exchange was closed down
32
1934 Establishment of the Lahore Stock Exchange
1936 Merger of the Lahore Stock Exchange with the Punjab Stock Exchange
1937 Re-organization and set up of the Madras Stock Exchange Limited (Pvt) Limited led by
improvement in stock market activities in South India with establishment of new textile mills and
plantation companies
1940 Uttar Pradesh Stock Exchange Limited and Nagpur Stock Exchange Limited was established
1944 Establishment of The Hyderabad Stock Exchange Limited
1947 Delhi Stock and Share Brokers Association Limited and The Delhi Stocks and Shares Exchange
Limited were established and later on merged into The Delhi Stock Exchange Association
Limited
Sources wwwsurfindiacom wwwappuonlinecom
271 Post Independence Scenario
The depression witnessed after the Independence led to closure of a lot of exchanges
in the country Lahore Stock Exchange was closed down after the partition of India
and later on merged with the Delhi Stock Exchange Bangalore Stock Exchange
Limited was registered in 1957 and got recognition only by 1963 Most of the other
Exchanges were in a miserable state till 1957 when they applied for recognition under
Securities Contracts (Regulations) Act 1956 The Exchanges that were recognized
under the Act were
Bombay Calcutta Madras Ahmadabad Delhi Hyderabad Bangalore Indore
272 Many more stock exchanges were established during 1980s
namely
Cochin Stock Exchange (1980)
Uttar Pradesh Stock Exchange Association Limited (at Kanpur 1982)
Pune Stock Exchange Limited (1982)
Ludhiana Stock Exchange Association Limited (1983)
Gauhati Stock Exchange Limited (1984)
Kanara Stock Exchange Limited (at Mangalore 1985)
33
Magadh Stock Exchange Association (at Patna 1986)
Jaipur Stock Exchange Limited (1989)
Bhubaneswar Stock Exchange Association Limited (1989)
Saurashtra Kutch Stock Exchange Limited (at Rajkot 1989)
Vadodara Stock Exchange Limited (at Baroda 1990)
Coimbatore Stock Exchange
Meerut Stock Exchange
At present there are twenty one recognized stock exchanges in India which does not
include the Over The Counter Exchange of India Limited (OTCEI) and the National
Stock Exchange of India Limited (NSEIL)
Government policies during 1980s also played a vital role in the development of the
Indian Stock Markets There was a sharp increase in number of Exchanges listed
companies as well as their capital which is visible from the following table
Table 23 Pattern of Growth of Stock Exchanges
Source SEBI annual report
273 Trading Pattern of the Indian Stock Market
Indian Stock Exchanges allow trading of securities of only those public limited
companies that are listed on the Exchange(s) They are divided into two categories
S
No
As on 31st December 1946 1961 1971 1980 1991 1995 2000 2005
1 No of Stock Exchanges 7 7 8 9 20 22 23 23
2 No of Listed Cos 1125 1203 1599 2265 6229 8593 9413 4731
5 Market value of Capital
of Listed Cos (Cr Rs)
971 1292 2675 6750 110279 478121 6319212 478121
34
Chart 25 Trading Pattern of the Indian Stock Market
Source wwwbseindiacom
274 Types of Transactions
The flowchart below describes the types of transactions that can be carried out on the
Indian stock exchanges
Chart 26 Types of Transactions
Source wwwbseindiacom
Listed Securities of Public limited companies
Specified securities (forward List)
Equity shares of company that are
- Dividend paying
- growth orinted companies
- paid up capital of atleast Rs50 million
- Market capitalisation of atleast Rs100 million
- has more than 20000 shareholders
Non specicied Securities (Cash List)
equity shares of companies not covered in specified securities
Transactions on Indian Stock Exchanges
Spot Delivery Transactions
Forward Transactions
35
Spot Delivery Transactions
Includes transactions that require delivery and payment within stipulated time
period at the time of entering into the contract
This period shall not be more than 14 days following the date of the contract
Forward Transactions
Transactions in which delivery and payment can be extended by further period
of 14 days each
The overall period should not exceed 90 days from the date of contract
Transactions permitted only in case of specified shares
275 Indian stock exchange allows a member broker to perform
following activities
Act as an agent
Buy and sell securities for clients and charge commission for the same
Act as a trader or dealer as a principal
Buy and sell securities on their account and risk
276 Over The Counter Exchange of India (OTCEI)
Traditionally trading in Stock Exchanges in India followed a conventional style
where people used to gather at the Exchange and bids and offers were made by open
outcry This age-old trading mechanism in the Indian stock markets used to create
much functional inefficiency Lack of liquidity and transparency long settlement
periods and benami transactions are a few examples that adversely affected investors
In order to overcome these inefficiencies OTCEI was incorporated in 1990 under the
Companies Act 1956 OTCEI is the first screen based nationwide stock exchange in
India created by Unit Trust of India Industrial Credit and Investment Corporation of
India Industrial Development Bank of India SBI Capital Markets Industrial Finance
Corporation of India General Insurance Corporation and its subsidiaries and Can
Bank Financial Services
36
Chart 27 Securities traded on the OTCEI
Source wwwbseindiacom
Listed Securities
Securities of the companies listed on the OTC
Can be bought or sold at any OTC counter across India
Should not be listed anywhere else
Permitted Securities
Certain securities (Shares and debentures listed on other exchanges)
Unites of Mutual funds can be traded
Initiated Debentures
An equity holding a minimum of one lakh debentures of a particular scrip can
offer them for trading on the OTC
Advantages of OTCEI
Greater liquidity and lesser risk of intermediary charges due to widely spread trading
mechanism across India The screen-based scrip less trading ensures transparency and
accuracy of prices Faster settlement and transfer process as compared to other
exchanges Shorter allotment procedure (in case of a new issue) than other exchanges
277 National Stock Exchange
In order to lift the Indian stock market trading system at par with the international
standards On the basis of the recommendations of high powered Pherwani
Securities teaded on the
OTCEI
Listed Securities
Permitted Securities
Initiated Debentures
37
Committee the National Stock Exchange was incorporated in 1992 by Industrial
Development Bank of India Industrial Credit and Investment Corporation of India
Industrial Finance Corporation of India all Insurance Corporations selected
commercial banks and others
2771 NSE provides exposure to investors in two types of markets
namely
Wholesale debt market
Capital market
Wholesale Debt Market - Similar to money market operations debt market
operations involve institutional investors and corporate bodies entering into
transactions of high value in financial instruments like treasury bills government
securities commercial papers etc
Capital market- A capital market is a market for securities (debt or equity) where
business enterprises and governments can raise long term funds It is defined as a
market in which money is defined as a market in which money is provided for periods
longer than a year34 as the raising of short term funds takes place on other markets
Capital markets may be classified as primary markets and secondary markets In
primary markets new stock or bond issues are sold to investors via a mechanism
known as underwriting In the secondary markets existing securities are sold and
bought among investors or traders usually on a securities exchange over the counter
or elsewhere
278 Trading at NSE amp BSE
Fully automated screen-based trading mechanism
Strictly follows the principle of an order-driven market
Trading members are linked through a communication network
34 Steven M Sheffrin (2003) Economics Principles in action Upper Saddle River Pearson Prentice
Hall
38
This network allows them to execute trade from their offices
The prices at which the buyer and seller are willing to transact will appear on
the screen
When the prices match the transaction will be completed
A confirmation slip will be printed at the office of the trading member
2781 Advantages of trading at NSE amp BSE
Integrated network for trading in stock market of India
Fully automated screen based system that provides higher degree of
transparency
Investors can transact from any part of the country at uniform prices
Greater functional efficiency supported by totally computerized network
28 THE BOMBAY STOCK EXCHANGE
Formerly the Stock Exchange Mumbai popularly called Bombay Stock Exchange
or BSE is the oldest stock exchange in Asia and has the greatest number of listed
companies in the world with 4700 listed as of August 2007 35
It is located at Dalal Street Mumbai India On 31 December 2007 the equity market
capitalization of the BSE was US $ 179 trillion making it the largest stock exchange
in South Asia and the 12th largest in the world
With over 4700 Indian companies list on the stock exchange [10]
and it has a
significant trading volume The BSE SENSEX (SENSITIVE INDEX) also called the
―BSE 30 is a widely used market index in India and Asia Though many other
exchanges exist BSE and the National Stock Exchange of India account for most of
the trading in shares in India
35 World Federation of Exchanges (2007) wwwworld-exchangesorg
39
281 History of the Bombay Stock exchange
Trading in securities has been in vogue in India for a little over 200 years Trading in
securities dates back 1793 most of them being transactions in loan securities of the
East India Company The broking community prospered as there was a rise in prices
which led to a share mania during 1861-65 This bubble burst in 1865 when the
American Civil War ended The brokers realized that investor confidence in the
securities market could be sustained only by organizing themselves into a regulated
body with defined rules and regulations The realization resulted in formation of ―The
Native Share and Stock Brokerslsquo Association which later came to be known as the
Bombay Stock Exchange In 1875 these brokers assembled at a place now called
Dalal Street
The Bombay Stock Exchange is a voluntary nonprofit making association of broker
members It emerged as a premier stock exchange after the 1960 The increased pace
of industrialization caused by the two world wars protection to the domestic industry
and the governmentlsquos fiscal policies aided the growth of new issues which in turn
helped the BSE to prosper The BSE dominated the Indian Capital Market by
accounting for more than 60 per cent of the all Indian turn over
Until 1992 the BSE operated like a closed club of selected members With the
securities scam outburst in 1992 and the SEBI taking over the rains of the Stock
Market the BSE had to bring about changes in its operational policies Until March
1995 the BSE had an open outcry system of trading However when faced with stiff
competition from NSE the countrylsquos first modern computerized and professionally
managed stock exchange set up in 1994 the BSE had to change its system of trading
and operation
On 14 March 1995 the BSE turned to electronic trading whereby brokers trade using
computers This system is known as the BSE On-line Trading System (BOLT)
The introduction of BOLT helped in improving trading volumes significantly
reducing the spread between buy and sell orders better trading in odd lot shares fixed
income instruments and dealings in the renunciation of rights shares
40
In 1995 BOLT was limited to Mumbai whereas the NSE was operating at the
national level As a result the BSE submitted a proposal for allowing installation of
terminals connected to BOLT in centers outside Mumbai After rejecting the proposal
four times on 29 october 1996 the SEBI finally allowed the BSE to use its BOLT
system nationwide Later the BSE set up a central depository system to dematerialize
shares and promote demate Account (trading)
282 Hours of Operation
Beginning of the Day Session 800 to 900
Trading Session 900 to 1530
Position Transfer Session 1530 to 1550
Closing Session 1550 to 1605
Option Exercise Session 1605 to 1635
Margin Session 1635 to 1650
Query Session 1650 to1735
End of Day Session 1735
The hours of operation for the BSE quoted above are stated in terms of the local time
(ie GMT+530) in Mumbai India
BSElsquos normal trading sessions are on all days of the week except Saturdays Sundays
and Holidays declared by the Exchange in advance 36
283 Services of BSE
BSE also had a wide range of services to empower investors and facilitate smooth
transactions These services are as follows
2831 Investor Services
The Dept of investor services redresses grievances of investors BSE was the first
exchange in the country to provide an amount of Rs 1 million towards the investor
36 Asia Technical Analysis with Phil Smith wwwreutersindianet
41
protection fund it is an amount higher than that of any exchange in the country BSE
launched a nationwide investor awareness program ―Safe Investing in the Stock
Market under which 264 programmers were held in more than 200 cities
2832 The BSE Online Trading (BOLT)
BSE on line Trading (BOLT) facilities on-line screen based trading in securities
BOLT is currently operating in 25000 trader work stations located across over 399
cities in India
2833 BSEWEBXcom
In February 2001 BSE introduced the worldlsquos first centralized exchange based
Internet trading system BSEWEBXcom This initiative enables investors anywhere
in the world to trade on BSE platform
2834 Surveillance
BSElsquos Online Surveillance System (BOSS) monitors on a real time basis the price
movements volume position and real time measurements of the default risk market
reconstruct and generation of cross market alerts
2835 BSE Training Institute
BTI imparts capital market training and certification in collaboration with reputed
management institutes and universities It offers over 40 courses on various aspects of
the capital mark and financial sector More than 20000 people have attended the BTI
program
284 Awards
Fowling awards were given to BSE
The world council of Corporate Governance has awarded the Golden Peacock
Global CSR Award for BSElsquos initiatives in corporate social responsibility
The Annual Reports and Accounts of BSE for the year ended March 312006 and
42
March 312007 have been awarded the ICAI awards for excellence in financial
reporting
The Human Resource Management at BSE has won the Asia-Pacific HRM awards
for its efforts in employer branding through talent management at work health
management at work and excellence in HR through technology
Drawing from its rich past and its equally robust performance in the recent times
BSE will continue to remain an icon in the Indian Capital Market
285 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 days closing price is taken for computation of Index closure
The use of Index Closure Algorithm prevents any intentional manipulation of the
closing index value
286 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 affect the
index values The BSE Index Cell does the day-to-day maintenance of the index
within the broad index policy framework set by the BSE Index Committee The BSE
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 BSE Index Committee comprises
of capital market expert fund managers market participants and members of the BSE
Governing Board
43
287 On-Line Computation of the Index
During trading hours value of the Index is calculated and disseminated on real time
basis This is done automatically on the basis of prices at which trades in Index
constituents are executed
288 Adjustment for Bonus Rights and Newly Issued Capital
SENSEX calculation needs to be adjusted for issue of Bonus or 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 BSE Index Cell the base value is adjusted which is used to alter
market capitalization of the component stocks to arrive at the SENSEX value The
BSE Index Cell keeps a close watch on the events that might affect the index on a
regular basis and carries out daily maintenance of all the 19 Indices
2881 Adjustments for Rights Issues
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 (ex-right) price An offsetting or
proportionate adjustment is then made to the Base Market capitalization
2882 Adjustments for Bonus Issue
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
2883 Other Issues 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
buy-back of shares corporate restructuring etc
44
289 Listing Categories
Before badla was resumed in 1996 there were only two categories of securities listed
on the BSE the specified group of shares comprising The securities in which carry
forward deals were allowed and the cash group shares in which no carry forward deals
were permitted Later it was observed that the facility of carry forward was not being
used in all the 94 scrips in the specified group Hence after badla was resumed the
size of the specified group was reduced to 32 scrips on 3 April 1996 The BSE later
decided to regroup the existing A and B group shares into three categories The BSE
delisted 637 companies for a period of 3 years during 2004-05 for non-compliance of
listing agreements
A Group This group consists of large stock with turnover and high floating stock
with large market capitalization In other words scrips with more liquidity and high
networth are included in this group At present there are 150 scrips in this group
B1 Group This group includes scrips of quality companies with equity above Rs 3
crore with high growth potential and trading frequency No carry forward facility was
allowed in this group in June 2000 there were 1803 scrips in this group
B2 Group Scrips in this group were just like those of B1 but with fortnightly
settlement However in September 1996 the BSE introduced weekly settlement for all
scrips listed on the exchange thus doing away with the distinction between the B1 and
B2 groups On June 2000 there were 3219 scrips in this group
Z Group Subsequently a Z group was introduced in 1999 with scrips of companies
that do not meet the rules regulations and stipulations laid down by the exchange It
is a buyer beware company These are some 300 scrips in the group All Z category
stocks result in delivers
F Group A new Flsquo group pertaining to debt market segment was started with effect
from 9 September 1996
S Group The BSE reduced post-public issue capital base requirement from Rs10
crore to Rs3 crore to attract listing by companies with a smaller capital base It also
45
started a new trading segment small cap stock segment known as the Slsquo segment
Corporate with minimum turnover of an equal amount would be eligible to list scrips
on this segment In addition stocks listed on the regional exchanges would also be
able to list on the lsquoSlsquo segment subject to meeting certain criteria
2810 Base Market capitalization Adjustment
The formula for adjusting the Base Market capitalization is as follows
New Base Market Capitalization (NBMC)
New Market capitalization
NBMC = Old Base Market capitalization x mdashmdashmdashmdashmdashmdashmdashmdashmdashmdashmdash
Old Market capitalization
To illustrate suppose a company issues right shares which increases the market
capitalization of the shares of that company by say Rs100 crores The existing Base
Market capitalization (Old Base Market capitalization) say is Rs2450 crores and the
aggregate market capitalization of all the shares included in the index before the right
issue is made is say Rs4781 crore The New Base Market capitalization will then
be
2450x (4781+100)
_____________________ = Rs250124 crores
4781
This figure of Rs 250124 crore will be used as the Base Market capitalization for
calculating the index number from then onwards till the next base change becomes
necessary
Index Review Frequency
The BSE 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
29 STOCK MARKET INDEX
The stock market index is the most important indices of all as it measures overall
market sentiment through a set of stocks that representative of the market The stock
46
market index is a barometer of the market behavior It reflects direction and indicates
day-to-day fluctuations in stock prices The market index reflects expectations about
the behavior of the economy as a whole It is a precursor of economic cycles The
function of a stock index is to provide investors with information regarding the
average share price in the market An ideal index must represent changes in the prices
of the scrips and reflect price movements of typical shares for better market
representation Stock index is a barometer of a nationlsquos economic health as market
prices reflect expectations about the economylsquos performance Stock indices termed as
leading economic as they indicate what is going to happen in the economy in the
future The returns generated in the stock market are based on future expectations A
good market index incorporates a set of scrips which have high market capitalization
and high liquidity Market capitalization is the sum of the market value of all the
stocks included in the index The market value is derived by multiplying the price of
the share outstanding In other words the bid-ask spread is minimum The index on a
day is calculated as the percentage of the aggregate market value of the set of scrips
incorporated in the index on that day to the average market value of the same scrips
during the base period
291 Definition of an Index
A price index is such as the stock market price of the individual securities in the
market It reflects the overall price or return movements of a group of securities
Movements in an index are determined by sample weighting and computational
procedure Sample is normally generated by random selection or try a non random
selection technique designed to incorporate desired characteristics are used to select
sample shares rather than by completely random selection Major criteria for selection
are market activity due representation to various industrial groups and to major stock
exchanges
292 Global Stock Market Indices
2921 The Dow Jones Industrial averagersquos
It is the most widely watched and quoted index because of its long existence The
Dow has 30 constituents and it follows the methodology of price based weighted
47
Changes to stocks included in the Dow are infrequent three stocks were
addeddropped in 1991 four in 1997 and four in 1999 The addition of Microsoft and
Intel in 1999 was the first inclusion of Nasdaq market stocks to the Dow 30
2922 The Nasdaq composite index
The index is the market capitalization weighted of prices for all the stocks listed in the
Nasdaq stock market The Nasdaq composite began on 8 February 1971 with a base
of 100
2923 The Nasdaq 100 index
Nasdaq 100 comprises the largest computer software and telecom stocks by market
capitalization on the Nasdaq For a company to be included in the Nasdaq 100 it must
have a minimum average trading volume of 100000 shares per day and must have
been trading on a major exchange for at least a year or two
2924 The S amp P 500 index
This index comprises 500 biggest publicly traded companies in the US by market
capitalization Most money managers treat the S amp P 500 as a proxy for the US stock
market The S amp P 500 tries to cover all major areas of US economy To be included a
company must be profitable the prospective company must not be closely hold and
must have a large trading volume for its shares
2925 The FTSE 100
The FTSE 100 consists of the largest 100 companies by full market Value listed on
the London Stock Exchange The FTSE 100 is the benchmark index to indicate the
performance of the European market It is a market capitalization weighted index that
also considers the free float weighted of individual stocks before including them in
the index
2926 The MSCI Indices
Include the MSCIEAFE (Europe Australia and Far East) MSCI Europe MSCI
world MSCI (EMF) and MSCI Pacific Basin Indices
48
The MSCI world Index is a free float adjusted market capitalization index that is
designed to measure global developed market equity performance As of April 2002
the MSCI world Index consisted of the MSCI world Index consisted of the following
23 developed market country indices
Australia Austria Belgium Canada Denmark Finland France Germany Greece
Hong Kong Ireland Italy Japan Netherlands New Zealand Norway Singapore
Portugal Spain Sweden Switzerland United Kingdom and the United States of
America
293 Methodology for Calculating The Index
2931 Price Weighted Index
In this method the price of each stock in the index is summed up which is then
equated to an index starting value An arbitrary date is set as the base and the
Laspeyerlsquos Price Index which measures price changes against a fixed base period
quantity weight is used In case of a stock split the market price of the stock falls and
these results in less weighted in the index The Dow Jones Industrial Average and
Nikkie 225 are price-weighted indices
2932 Equal Weighting
In this method each stocklsquos percentage weight in the index is equal and hence all
stocks have an equal influence on the index movement The value line index at
Kansas City Board of Trade (KCBT) is an equal weighted index
2933 Market Capitalization Weighted
29331 Full Market Capitalization Method
In this method the number of shares outstanding multiplied by the market price of a
companylsquos share determines the scriplsquos weighted in the index The shares with the
highest market capitalization would have a higher weighted and would be most
influential in this type of index Eg S amp P 500 Index in USA and S amp P CNX Nify in
India
49
29332 Modified Capitalization Weighted
This method seeks to limit the influence of the largest stocks in the index which
otherwise would dominate the entire index This method sets a limit on the largest
stock or a group of stocks The NASDAQ 100 Index is calculated by using this
method
294 Free Float Market Capitalization Method
2941 Concept
Free float methodology refers to an index construction methodology that takes in to
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 Strategic holding government 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
All BSE indices with exception of BSE-PSU index have adopted the free-float
methodology
2942 Definition of Free Float
Share holding of investor that would not in the normal course come into the
open market for trading are treated as ―Controlling Strategic Holding and
hence not included in free float specifically the following categories of
holding are generally excluded from the definition of free float
Shares hold by foundersdirectorsacquires which has control element
Shares held by person with ―Controlling Interestlsquo
Shares held by Govt as promoters
50
Holding through the FDI Route
Strategic Stakes by private corporate bodiesindividuals
Equity held by employee welfare trusts
Locked-in-shares and shares which not be sold in the open market in normal
course
2943 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-agrave-Vis an investible
index This enables an apple-to-apple comparison thereby facilitating better
evaluation of performance of active managers
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 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
The free float methodology of index construction is considered to be an industry best
practice and all major index providers like MSCI FTSE SampP 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
51
29441 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 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 055 means that only 55 of the market
capitalization of the company will be considered for index calculation
Table 24 Free-float Bands
Free-Float Free-Float Factor Free-Float Free-Float Factor
gt0 - 5 005 gt50 - 55 055
gt5 - 10 010 gt55 - 60 060
gt10 - 15 015 gt60 - 65 065
gt15 - 20 020 gt65 - 70 070
gt20 - 25 025 gt70 - 75 075
gt25 - 30 030 gt75 - 80 080
gt30 - 35 035 gt80 - 85 085
gt35 - 40 040 gt85 - 90 090
gt40 - 45 045 gt90 - 95 095
gt45 - 50 050 gt95 - 100 100
Source wwwbseindiacom
295 BSE Indices
For the premier stock exchange that pioneered the securities transaction business
in India over a century of experience is a proud achievement A lot has changed since
1875 when 318 persons by paying a then princely amount of Re 1 became members
of what today is called Bombay Stock Exchange Limited (BSE) Over the decades
the stock market in the country has passed through good and bad periods The journey
52
in the 20th century has not been an easy one Till the decade of eighties there was no
measure or scale that could precisely measure the various ups and downs in the Indian
stock market BSE in 1986 came out with a Stock Index-SENSEX- that subsequently
became the barometer of the Indian stock market
The launch of SENSEX in 1986 was later followed up in January 1989 by
introduction of BSE National Index (Base 1983-84 = 100) It comprised 100 stocks
listed at five major stock exchanges in India - Mumbai Calcutta Delhi Ahmadabad
and Madras The BSE National Index was renamed BSE-100 Index from October 14
1996 and since then it is being calculated taking into consideration only the prices of
stocks listed at BSE BSE launched the dollar-linked version of BSE-100 index on
May 22 2006
With a view to provide a better representation of the increasing number of listed
companies larger market capitalization and the new industry sectors BSE launched
on 27th May 1994 two new index series viz the BSE-200 and the DOLLEX-200
Since then BSE has come a long way in attuning itself to the varied needs of
investors and market participants In order to fulfill the need for still broader
segment-specific and sector-specific indices BSE has continuously been increasing
the range of its indices BSE-500 Index and 5 sectorial indices were launched in 1999
In 2001 BSE launched BSE-PSU Index DOLLEX-30 and the countrys first free-
float based index - the BSE TEC Index Over the years BSE shifted all its indices to
the free-float methodology
BSE disseminates information on the Price-Earnings Ratio the Price to Book Value
Ratio and the Dividend Yield Percentage on day-to-day basis of all its major indices
The values of all BSE indices are updated on real time basis during market hours and
displayed through the BOLT system BSE website and news wire agencies
All BSE Indices are reviewed periodically by the BSE Index Committee This
Committee which comprises eminent independent finance professionals frames the
broad policy guidelines for the development and maintenance of all BSE indices The
BSE Index Cell carries out the day-to-day maintenance of all indices and conducts
research on development of new indices
53
2951 BSE-100 Index
A broad-based index the BSE-100 was formerly known as the BSE National index
This Index has 1983-84 as the base year and was launched in 1989 In line with the
shift of the BSE Indices to the globally accepted Free-Float methodology BSE-100
was shifted to Free-Float methodology effective from April 5 2004 The method of
computation of Free-Float index and determination of free-float factors is similar to
the methodology for SENSEX
Table 25 Index Specification
Base Year 1983-84
Base Index Value 100
Date of Launch 3-Jan-89
Method of calculation Launched on full market capitalization
method and effective April 05 2004
calculation method shifted to free-float
market capitalization
Number of scrips 100
Index calculation frequency Real Time
Source wwwbseindiacom
2952 Base Year
The financial year 1983-84 has been chosen as the base year The price stability
during that year and proximity to the index series were the main consideration for
choice of 1983-84 as the base year The base value was fixed at 100 points
2953 Dollex-100
BSE also calculates a dollar-linked version of SENSEX and historical values of this
index are available since its inception
2954 BSE-100 index - Scrip Selection Criteria
The general guidelines for selection of constituents in BSE-100 are as follows
Trading Frequency The scrip should have been traded on 95 of the trading days
54
in the last three months Exceptions can be made for extreme reasons like scrip
suspension etc
Final Rank The scrip should figure in the top 200 companies listed by final rank
The final rank is arrived at by assigning 75 weighted to the rank on the basis of
three-month average full market capitalization and 25 weighted to the liquidity rank
based on three-month average daily turnover amp three-month average impact cost
IndustrySector Representation Scrip selection would generally take into account a
balanced sectorial representation of the listed companies in the universe of BSE
Track Record In the opinion of the BSE Index Committee the company should
have an acceptable track record
210 STOCK MARKET VOLATILITY
2101 Meaning
Volatility is a measure for variation of price of a financial instrument over time
Historic volatility is derived from time series of past market prices An implied
volatility is derived from the market price of a market traded derivative (in particular
an option) Volatility does not measure the direction of price changes merely their
dispersion This is because when calculating standard deviation (or variance) all
differences are squared so that negative and positive differences are combined into
one quantity Two instruments with different volatilities may have the same expected
return but the instrument with higher volatility will have larger swings in values over
a given period of time
For example a lower volatility stock may have an expected (average) return of 7
with annual volatility of 5 This would indicate returns from approximately negative
3 to positive 17 most of the time (19 times out of 20 or 95 via a two standard
deviation rule) A higher volatility stock with the same expected return of 7 but
with annual volatility of 20 would indicate returns from approximately negative
33 to positive 47 most of the time (19 times out of 20 or 95) These estimates
assume a normal distribution in reality stocks are found to be leptokurtotic
55
2102 Terminology used in volatility
Volatility as described here refers to the actual current volatility of a financial
instrument for a specified period (for example 30 days or 90 days) It is the volatility
of a financial instrument based on historical prices over the specified period with the
last observation the most recent price This phrase is used particularly when it is
wished to distinguish between the actual current volatility of an instrument and
actual historical volatility which refers to the volatility of a financial instrument
over a specified period but with the last observation on a date in the past
actual future volatility which refers to the volatility of a financial instrument
over a specified period starting at the current time and ending at a future date
(normally the expiry date of an options)
historical implied volatility which refers to the implied volatility observed from
historical prices of the financial instrument (normally options)
current implied volatility which refers to the implied volatility observed from
current prices of the financial instrument
future implied volatility which refers to the implied volatility observed from
future prices of the financial instrument
For a financial instrument whose price follows a random walk or wiener process the
width of the distribution increases as time increases This is because there is an
increasing profitability that the instruments price will be farther away from the initial
price as time increases However rather than increase linearly the volatility increases
with the square-root of time as time increases because some fluctuations are expected
to cancel each other out so the most likely deviation after twice the time will not be
twice the distance from zero
2103 Usefulness of volatility for Investors
Investors care about volatility for five reasons
1 The wider the swings in an investments price the harder emotionally it is to
not worry
2 Price volatility of a trading instrument can define position sizing in a portfolio
56
3 When certain cash flows from selling a security are needed at a specific future
date higher volatility means a greater chance of a shortfall
4 Higher volatility of returns while saving for retirement results in a wider
distribution of possible final portfolio values
5 Higher volatility of return when retired gives withdrawals a larger permanent
impact on the portfolios value
6 Price volatility presents opportunities to buy assets cheaply and sell when
overpriced
23
Corporations issue new securities in the primary market usually with the help of
investment bankers Company negotiates price and then makes the securities available
for its clients and other investors This is called an initial public offering (IPO)
In this primary market corporations receive the proceeds of stock sales After this
initial offering the securities are bought and sold in the secondary market The
corporation is not usually involved in the trading of its stock in the secondary market
therefore stock exchanges will essentially function as a secondary market By
providing investors the opportunity to trade financial instruments the stock exchanges
support the performance of the primary markets This arrangement makes it easier for
a corporation to raise the funds that they need to build and expand their businesses
Although corporations do not directly benefit from secondary market transactions the
managers of a corporation closely monitor the price of the corporationlsquos stock in
secondary markets Reasons for this concern involves the cost of raising new funds
for further business expansion the perceived strength of a company (and whether it
is vulnerable to a takeover) and of course their options and bonus packages
There are benefits and new obligations that come from raising capital through a public
offering
Benefits
Companylsquos access to capital will increase since you can contact more
potential investors
Company may become more widely known
Company may obtain financing more easily in the future if investor interest in
your company grows enough to sustain a secondary trading market in your
securities
Controlling shareholders such as the companys officers or directors may
have a ready market for their shares which means that they can more easily
sell their interests at retirement for diversification or for some other reason
24
Company may be able to attract and retain more highly qualified personnel if
it can offer stock options bonuses or other incentives with a known market
value
The image of company may be improved
Obligations
Company must continue to keep shareholders informed about the companys
business operations financial condition and management incurring additional
costs and new legal obligations
Company may be liable if you do not fulfill these new legal obligations
Company may lose some flexibility in managing your companys affairs
particularly when shareholders must approve your actions
Company public offering will take time and money to accomplish
232 Mobilizing savings for investment
When people draw their savings and invest in shares it leads to a
more rational allocation of resources because funds which could have been
consumed or kept in idle deposits banks are mobilized and redirected to
promote business activity with benefits for several economic sectors such
as agriculture commerce and industry resulting in stronger economic growth and
higher productivity levels of firms
233 Facilitating company growth
The smooth functioning of all these activities facilitates economic growth in that
lower costs and enterprise risks promote the production of goods and services as well
as employment In this way the financial system contributes to increased prosperity
An important aspect of modern financial markets however including the stock
markets is absolute discretion For example American stock markets see more
unrestrained acceptance of any firm than in smaller markets attention must be given to
25
the foreign Companies view acquisitions as an opportunity to expand product lines
increase distribution channels hedge against volatility increase its market share or
acquire other necessary business assets A takeover bid or a merger agreement
through the stock market is one of the simplest and most common ways for a
company to grow by acquisition or fusion
234 Profit sharing
Both casual and professional stock investors through dividends and stock
price increases that may result in capital gains will share in the wealth of profitable
businesses
235 Corporate governance
By having a wide and varied scope of owners companies generally tend to improve
on their management standards and efficiency in order to satisfy the demands of these
shareholders and the more stringent rules for public corporations imposed by public
stock exchanges and the government Consequently it is alleged that public
companies (companies that are owned by shareholders who are members of the
general public and trade shares on public exchanges) tend to have better management
records than privately-held companies (those companies where shares are not publicly
traded often owned by the company founders andor their families and heirs or
otherwise by a small group of investors) However some well-documented cases are
known where it is alleged that there has been considerable slippage in corporate
governance on the part of some public companies The dot-com bubbles in the early
2000s and the subprime mortgage crisis in 2007-08 are classical examples of
corporate mismanagement Companies like Petscom (2000) Enron
Corporation (2001) OneTel (2001) Sunbeam(2001) Webyan (2001) Adelphia
(2002) MCI World Com (2002) Parmalat (2003) American International Group
(2008) Lehman Brothers (2008) and Satyam Computer Service(2009) were among
the most widely scrutinized by the media
26
236 Creating investment opportunities for small investors
As opposed to other businesses that require huge capital outlay investing in shares is
open to both the large and small stock investors because a person buys the number of
shares they can afford Therefore the Stock Exchange provides the opportunity for
small investors to own shares of the same companies as large investors
The liquidity that an exchange provides affords investors the ability to quickly and
easily sell securities This is an attractive feature of investing in stocks compared to
other less liquid investments such as real estate
237 Government capital-raising for development projects
Governments at various levels may decide to borrow money in order to finance
infrastructure projects such as sewage and water treatment works or housing estates
by selling another category of securities known as bonds These bonds can be raised
through the Stock Exchange whereby members of the public buy them thus loaning
money to the government The issuance of such bonds can obviate the need to directly
tax the citizens in order to finance development although by securing such bonds
with the full faith and credit of the government instead of with collateral the result is
that the government must tax the citizens or otherwise raise additional funds to make
any regular coupon payments and refund the principal when the bonds mature
238 Barometer of the economy
Form the history of many countries it has shown that the price of share and other
assets is an important part of the dynamics of economic activity The price of these
assets can influence or be an up and coming economy Many times the stock market is
considered the primary indicator of a countrylsquos economic development and strength
If the stock market is rising it tends to be associated with increased business and
investments and if the stock market if falling associated with deceased business and
investments It can also be observed that share prices also affect the wealth of
households and their consumption At the stock exchange share price rise or fall may
depending largely on market forces and sentiments When the economy is stable or
growing the share prices tense to raise or remain stable but when economic face
recession depression or financial crisis result in stock market crash Therefore the
27
movement of share prices and in general of the stock indexes can be an indicator of
the general trend in the economy
24 MAJOR STOCK EXCHANGES
Twenty Major Stock Exchanges Of The World Market Capitalization amp Year-to-date
Total Turnover at the end of August 2009
Table 21 Major Stock Exchanges of World
(August 2009 Figure in Million USD) Region Stock Exchange Market Value
Total Share
Turnovers
America Satildeo Paulo Stock Exchange 103251840 36195900
America Toronto Stock Exchange 143287700 79819310
America New York Stock Exchange 1084200190 1215862060
Asia-Pacific Australian Securities Exchange 106651320 56091280
Asia-Pacific Bombay Stock Exchange 108257200 17117620
Asia-Pacific Hong Kong Stock Exchange 194551770 97022760
Asia-Pacific Korea Exchange 72712530 105047380
Asia-Pacific National Stock Exchange of India 101910900 50665230
Asia-Pacific Shanghai Stock Exchange 214275680 331576850
Asia-Pacific Shenzhen Stock Exchange 59632020 170125680
Asia-Pacific Tokyo Stock Exchange 347860250 267598330
Europe Euro next 260509760 119596220
Europe Frankfurt Stock Exchange (Deutsche Boumlrse) 120429200 158973670
Europe London Stock Exchange 256049110 232151850
Europe Madrid Stock Exchange (Bolsas y Mercados
Espantildeoles)
117852560 104075110
Europe Milan Stock Exchange (Borsa Italiana) 63667480 56575930
Europe Nordic Stock Exchange Group OMX1 78114630 50304990
Europe Swiss Exchange 99235640 52086750
Note includes the Copenhagen Helsinki Iceland Stockholm Tallinn Riga and
Vilnius Stock Exchanges
Sources World Federation of Exchanges - Statistics Monthly
Remarks There are 2 pending major mergers NASDAQ with OMX and London
Stock Exchange with Milan Stock Exchange
28
Chart 23 Market Value
Chart 24 Total Share Turnovers
Source From the table 21
000 400000000 800000000 1200000000
Satildeo Paulo Stock Exchange
Toronto Stock ExchangeNew York Stock Exchange
Australian Securities ExchangeBombay Stock Exchange
Hong Kong Stock ExchangeKorea Exchange
National Stock Exchange of India
Shanghai Stock ExchangeShenzhen Stock Exchange
Tokyo Stock ExchangeEuro next
Frankfurt Stock Exchange (Deutsche Boumlrse)
London Stock ExchangeMadrid Stock Exchange (Bolsas y hellip
Milan Stock Exchange (Borsa Italiana)Nordic Stock Exchange Group OMX1
Swiss Exchange Market hellip
000 500000000 1000000000 1500000000
Satildeo Paulo Stock ExchangeToronto Stock Exchange
New York Stock ExchangeAustralian Securities Exchange
Bombay Stock ExchangeHong Kong Stock Exchange
Korea ExchangeNational Stock Exchange of India
Shanghai Stock ExchangeShenzhen Stock Exchange
Tokyo Stock ExchangeEuro next
Frankfurt Stock Exchange (Deutsche hellipLondon Stock Exchange
Madrid Stock Exchange (Bolsas y hellipMilan Stock Exchange (Borsa Italiana)Nordic Stock Exchange Group OMX1
Swiss Exchange Total Share hellip
29
25 REQUIREMENTS BY STOCK EXCHANGE
Companies have to meet the requirements of the exchange in order to have their
stocks and shares listed and traded there but requirements vary by stock exchanges
251 Bombay Stock Exchange
Bombay Stock Exchange (BSE) has requirements for a minimum market
capitalization of Rs250 Million and minimum public float equivalent to Rs100
Million31
252 London Stock Exchange
The main market of the London Stock Exchange has requirements for a minimum
market capitalization (pound700000) three years of audited financial statements
minimum public float (25 per cent) and sufficient working capital for at least 12
months from the date of listing
253 NASDAQ Stock Exchange
To be listed on the NASDAQ a company must have issued at least 125 million shares
of stock worth at least $70 million and must have earned more than $11 million over
the last three years 32
254 New York Stock Exchange
To be listed on the New York Stock Exchange (NYSE) a company must have issued
at least a million shares of stock worth $100 million and must have earned more than
$10 million over the last three years 33
255 Other types of exchanges
In the 19th century exchanges were opened to trade forward
contracts on commodities Exchange traded forward contracts are called futures
contracts These commodity exchanges later started offering future contracts on other
31 wwwbseindiacomaboutabintrobselistsecasp 32 NASDAQ Corporate -NASDAQ Listing Information wwnasdaqcomaboutlisting_informationstm 33 wwwnysecomFramesethtmldisplayPage=listed
30
products such as interest rates and shares as well as Options contracts They are now
generally known as futures exchanges
26 OWNERSHIP
Stock exchanges originated as mutual organizations owned by its member stock
brokers There has been a recent trend for stock exchanges to demutualize where the
members sell their shares in an initial public offering In this way the mutual
organization becomes a corporation with shares that are listed on a stock exchange
Examples are
Australian Securities Exchange (1998) Euro next (merged with New York Stock
Exchange) NASDAQ (2002) The New York Stock Exchange (2005) Bolsas
Mercados Espanoles and the Sao Paulo Stock Exchange (2007) The Shenzhen and
Shanghai stock exchanges can be characterized as quasi-state institutions insofar as
they were created by government bodies in China and their leading personnel are
directly appointed by the China Securities Regulatory Commission
27 HISTORY OF INDIAN STOCK MARKET
The stock exchange in Mumbai is more than 100 years old The origin of the stock
market in India dates back to the end of the eighteenth century when long term
negotiable securities were first issued The real beginning however occurred in the
middle of the nine teeth century after the enactment of the Companies Act in 1850
which introduced the feature of limited liability and generated investor interest in
corporate securities
The Native Share and Stock Brokerslsquo Association now known as the Bombay Stock
Exchange (BSE) was formed in Bombay (now Mumbai) in 1875 This was followed
by the formation of association in Ahmadabad in 1894 Calcutta (now Kolkata) in
1908 and Madras (now Chennai) in 1937 In order to promote the orderly
development of the stock market the central government introduced a comprehensive
legislation called the Securities Contracts (Regulation) Act 1956
31
The Calcutta Stock Exchange (CSE) was the largest stock exchange in India till the
1960s In 1961 there were 1203 listed companies across the various stock exchanges
of the country Of these 576 were listed on the CSE and 297 on the BSE However
during the later half of the 1960s the relative importance of the CSE declined while
that of the BSE increased sharply
One of the oldest stock markets in Asia the Indian Stock Markets have a 200 years
old history
Table 22 Origin of Indian Stock Market
Year Events
18th
Century
East India Company was the dominant institution and by end of the century business in its loan
securities gained full momentum
1830s Business on corporate stocks and shares in Bank and Cotton presses started in Bombay Trading list
by the end of 1839 got broader
1840s Recognition from banks and merchants to about half a dozen brokers
1850s Rapid development of commercial enterprise saw brokerage business attracting more people into
the business
1860s The number of brokers increased to 60
1860-61 The American Civil War broke out which caused a stoppage of cotton supply from United States of
America marking the beginning of the Share Mania in India
1862-63 The number of brokers increased to about 200 to 250
1865 A disastrous slump began at the end of the American Civil War (as an example Bank of Bombay
Share which had touched Rs 2850 could only be sold at Rs 87)
1874 With the rapidly developing share trading business brokers used to gather at a street (now well
known as Dalal Street) for the purpose of transacting business
1875 The Native Share and Stock Brokers Association (also known as The Bombay Stock
Exchange) was established in Bombay
1880s Development of cotton mills industry and set up of many others
1894 Establishment of The Ahmadabad Share and Stock Brokers Association
1880 -
90s
Sharp increase in share prices of jute industries in 1870s was followed by a boom in tea stocks and
coal
1908 The Calcutta Stock Exchange Association was formed
1920 Madras witnessed boom and business at The Madras Stock Exchange was transacted with 100
brokers
1923 When recession followed number of brokers came down to 3 and the Exchange was closed down
32
1934 Establishment of the Lahore Stock Exchange
1936 Merger of the Lahore Stock Exchange with the Punjab Stock Exchange
1937 Re-organization and set up of the Madras Stock Exchange Limited (Pvt) Limited led by
improvement in stock market activities in South India with establishment of new textile mills and
plantation companies
1940 Uttar Pradesh Stock Exchange Limited and Nagpur Stock Exchange Limited was established
1944 Establishment of The Hyderabad Stock Exchange Limited
1947 Delhi Stock and Share Brokers Association Limited and The Delhi Stocks and Shares Exchange
Limited were established and later on merged into The Delhi Stock Exchange Association
Limited
Sources wwwsurfindiacom wwwappuonlinecom
271 Post Independence Scenario
The depression witnessed after the Independence led to closure of a lot of exchanges
in the country Lahore Stock Exchange was closed down after the partition of India
and later on merged with the Delhi Stock Exchange Bangalore Stock Exchange
Limited was registered in 1957 and got recognition only by 1963 Most of the other
Exchanges were in a miserable state till 1957 when they applied for recognition under
Securities Contracts (Regulations) Act 1956 The Exchanges that were recognized
under the Act were
Bombay Calcutta Madras Ahmadabad Delhi Hyderabad Bangalore Indore
272 Many more stock exchanges were established during 1980s
namely
Cochin Stock Exchange (1980)
Uttar Pradesh Stock Exchange Association Limited (at Kanpur 1982)
Pune Stock Exchange Limited (1982)
Ludhiana Stock Exchange Association Limited (1983)
Gauhati Stock Exchange Limited (1984)
Kanara Stock Exchange Limited (at Mangalore 1985)
33
Magadh Stock Exchange Association (at Patna 1986)
Jaipur Stock Exchange Limited (1989)
Bhubaneswar Stock Exchange Association Limited (1989)
Saurashtra Kutch Stock Exchange Limited (at Rajkot 1989)
Vadodara Stock Exchange Limited (at Baroda 1990)
Coimbatore Stock Exchange
Meerut Stock Exchange
At present there are twenty one recognized stock exchanges in India which does not
include the Over The Counter Exchange of India Limited (OTCEI) and the National
Stock Exchange of India Limited (NSEIL)
Government policies during 1980s also played a vital role in the development of the
Indian Stock Markets There was a sharp increase in number of Exchanges listed
companies as well as their capital which is visible from the following table
Table 23 Pattern of Growth of Stock Exchanges
Source SEBI annual report
273 Trading Pattern of the Indian Stock Market
Indian Stock Exchanges allow trading of securities of only those public limited
companies that are listed on the Exchange(s) They are divided into two categories
S
No
As on 31st December 1946 1961 1971 1980 1991 1995 2000 2005
1 No of Stock Exchanges 7 7 8 9 20 22 23 23
2 No of Listed Cos 1125 1203 1599 2265 6229 8593 9413 4731
5 Market value of Capital
of Listed Cos (Cr Rs)
971 1292 2675 6750 110279 478121 6319212 478121
34
Chart 25 Trading Pattern of the Indian Stock Market
Source wwwbseindiacom
274 Types of Transactions
The flowchart below describes the types of transactions that can be carried out on the
Indian stock exchanges
Chart 26 Types of Transactions
Source wwwbseindiacom
Listed Securities of Public limited companies
Specified securities (forward List)
Equity shares of company that are
- Dividend paying
- growth orinted companies
- paid up capital of atleast Rs50 million
- Market capitalisation of atleast Rs100 million
- has more than 20000 shareholders
Non specicied Securities (Cash List)
equity shares of companies not covered in specified securities
Transactions on Indian Stock Exchanges
Spot Delivery Transactions
Forward Transactions
35
Spot Delivery Transactions
Includes transactions that require delivery and payment within stipulated time
period at the time of entering into the contract
This period shall not be more than 14 days following the date of the contract
Forward Transactions
Transactions in which delivery and payment can be extended by further period
of 14 days each
The overall period should not exceed 90 days from the date of contract
Transactions permitted only in case of specified shares
275 Indian stock exchange allows a member broker to perform
following activities
Act as an agent
Buy and sell securities for clients and charge commission for the same
Act as a trader or dealer as a principal
Buy and sell securities on their account and risk
276 Over The Counter Exchange of India (OTCEI)
Traditionally trading in Stock Exchanges in India followed a conventional style
where people used to gather at the Exchange and bids and offers were made by open
outcry This age-old trading mechanism in the Indian stock markets used to create
much functional inefficiency Lack of liquidity and transparency long settlement
periods and benami transactions are a few examples that adversely affected investors
In order to overcome these inefficiencies OTCEI was incorporated in 1990 under the
Companies Act 1956 OTCEI is the first screen based nationwide stock exchange in
India created by Unit Trust of India Industrial Credit and Investment Corporation of
India Industrial Development Bank of India SBI Capital Markets Industrial Finance
Corporation of India General Insurance Corporation and its subsidiaries and Can
Bank Financial Services
36
Chart 27 Securities traded on the OTCEI
Source wwwbseindiacom
Listed Securities
Securities of the companies listed on the OTC
Can be bought or sold at any OTC counter across India
Should not be listed anywhere else
Permitted Securities
Certain securities (Shares and debentures listed on other exchanges)
Unites of Mutual funds can be traded
Initiated Debentures
An equity holding a minimum of one lakh debentures of a particular scrip can
offer them for trading on the OTC
Advantages of OTCEI
Greater liquidity and lesser risk of intermediary charges due to widely spread trading
mechanism across India The screen-based scrip less trading ensures transparency and
accuracy of prices Faster settlement and transfer process as compared to other
exchanges Shorter allotment procedure (in case of a new issue) than other exchanges
277 National Stock Exchange
In order to lift the Indian stock market trading system at par with the international
standards On the basis of the recommendations of high powered Pherwani
Securities teaded on the
OTCEI
Listed Securities
Permitted Securities
Initiated Debentures
37
Committee the National Stock Exchange was incorporated in 1992 by Industrial
Development Bank of India Industrial Credit and Investment Corporation of India
Industrial Finance Corporation of India all Insurance Corporations selected
commercial banks and others
2771 NSE provides exposure to investors in two types of markets
namely
Wholesale debt market
Capital market
Wholesale Debt Market - Similar to money market operations debt market
operations involve institutional investors and corporate bodies entering into
transactions of high value in financial instruments like treasury bills government
securities commercial papers etc
Capital market- A capital market is a market for securities (debt or equity) where
business enterprises and governments can raise long term funds It is defined as a
market in which money is defined as a market in which money is provided for periods
longer than a year34 as the raising of short term funds takes place on other markets
Capital markets may be classified as primary markets and secondary markets In
primary markets new stock or bond issues are sold to investors via a mechanism
known as underwriting In the secondary markets existing securities are sold and
bought among investors or traders usually on a securities exchange over the counter
or elsewhere
278 Trading at NSE amp BSE
Fully automated screen-based trading mechanism
Strictly follows the principle of an order-driven market
Trading members are linked through a communication network
34 Steven M Sheffrin (2003) Economics Principles in action Upper Saddle River Pearson Prentice
Hall
38
This network allows them to execute trade from their offices
The prices at which the buyer and seller are willing to transact will appear on
the screen
When the prices match the transaction will be completed
A confirmation slip will be printed at the office of the trading member
2781 Advantages of trading at NSE amp BSE
Integrated network for trading in stock market of India
Fully automated screen based system that provides higher degree of
transparency
Investors can transact from any part of the country at uniform prices
Greater functional efficiency supported by totally computerized network
28 THE BOMBAY STOCK EXCHANGE
Formerly the Stock Exchange Mumbai popularly called Bombay Stock Exchange
or BSE is the oldest stock exchange in Asia and has the greatest number of listed
companies in the world with 4700 listed as of August 2007 35
It is located at Dalal Street Mumbai India On 31 December 2007 the equity market
capitalization of the BSE was US $ 179 trillion making it the largest stock exchange
in South Asia and the 12th largest in the world
With over 4700 Indian companies list on the stock exchange [10]
and it has a
significant trading volume The BSE SENSEX (SENSITIVE INDEX) also called the
―BSE 30 is a widely used market index in India and Asia Though many other
exchanges exist BSE and the National Stock Exchange of India account for most of
the trading in shares in India
35 World Federation of Exchanges (2007) wwwworld-exchangesorg
39
281 History of the Bombay Stock exchange
Trading in securities has been in vogue in India for a little over 200 years Trading in
securities dates back 1793 most of them being transactions in loan securities of the
East India Company The broking community prospered as there was a rise in prices
which led to a share mania during 1861-65 This bubble burst in 1865 when the
American Civil War ended The brokers realized that investor confidence in the
securities market could be sustained only by organizing themselves into a regulated
body with defined rules and regulations The realization resulted in formation of ―The
Native Share and Stock Brokerslsquo Association which later came to be known as the
Bombay Stock Exchange In 1875 these brokers assembled at a place now called
Dalal Street
The Bombay Stock Exchange is a voluntary nonprofit making association of broker
members It emerged as a premier stock exchange after the 1960 The increased pace
of industrialization caused by the two world wars protection to the domestic industry
and the governmentlsquos fiscal policies aided the growth of new issues which in turn
helped the BSE to prosper The BSE dominated the Indian Capital Market by
accounting for more than 60 per cent of the all Indian turn over
Until 1992 the BSE operated like a closed club of selected members With the
securities scam outburst in 1992 and the SEBI taking over the rains of the Stock
Market the BSE had to bring about changes in its operational policies Until March
1995 the BSE had an open outcry system of trading However when faced with stiff
competition from NSE the countrylsquos first modern computerized and professionally
managed stock exchange set up in 1994 the BSE had to change its system of trading
and operation
On 14 March 1995 the BSE turned to electronic trading whereby brokers trade using
computers This system is known as the BSE On-line Trading System (BOLT)
The introduction of BOLT helped in improving trading volumes significantly
reducing the spread between buy and sell orders better trading in odd lot shares fixed
income instruments and dealings in the renunciation of rights shares
40
In 1995 BOLT was limited to Mumbai whereas the NSE was operating at the
national level As a result the BSE submitted a proposal for allowing installation of
terminals connected to BOLT in centers outside Mumbai After rejecting the proposal
four times on 29 october 1996 the SEBI finally allowed the BSE to use its BOLT
system nationwide Later the BSE set up a central depository system to dematerialize
shares and promote demate Account (trading)
282 Hours of Operation
Beginning of the Day Session 800 to 900
Trading Session 900 to 1530
Position Transfer Session 1530 to 1550
Closing Session 1550 to 1605
Option Exercise Session 1605 to 1635
Margin Session 1635 to 1650
Query Session 1650 to1735
End of Day Session 1735
The hours of operation for the BSE quoted above are stated in terms of the local time
(ie GMT+530) in Mumbai India
BSElsquos normal trading sessions are on all days of the week except Saturdays Sundays
and Holidays declared by the Exchange in advance 36
283 Services of BSE
BSE also had a wide range of services to empower investors and facilitate smooth
transactions These services are as follows
2831 Investor Services
The Dept of investor services redresses grievances of investors BSE was the first
exchange in the country to provide an amount of Rs 1 million towards the investor
36 Asia Technical Analysis with Phil Smith wwwreutersindianet
41
protection fund it is an amount higher than that of any exchange in the country BSE
launched a nationwide investor awareness program ―Safe Investing in the Stock
Market under which 264 programmers were held in more than 200 cities
2832 The BSE Online Trading (BOLT)
BSE on line Trading (BOLT) facilities on-line screen based trading in securities
BOLT is currently operating in 25000 trader work stations located across over 399
cities in India
2833 BSEWEBXcom
In February 2001 BSE introduced the worldlsquos first centralized exchange based
Internet trading system BSEWEBXcom This initiative enables investors anywhere
in the world to trade on BSE platform
2834 Surveillance
BSElsquos Online Surveillance System (BOSS) monitors on a real time basis the price
movements volume position and real time measurements of the default risk market
reconstruct and generation of cross market alerts
2835 BSE Training Institute
BTI imparts capital market training and certification in collaboration with reputed
management institutes and universities It offers over 40 courses on various aspects of
the capital mark and financial sector More than 20000 people have attended the BTI
program
284 Awards
Fowling awards were given to BSE
The world council of Corporate Governance has awarded the Golden Peacock
Global CSR Award for BSElsquos initiatives in corporate social responsibility
The Annual Reports and Accounts of BSE for the year ended March 312006 and
42
March 312007 have been awarded the ICAI awards for excellence in financial
reporting
The Human Resource Management at BSE has won the Asia-Pacific HRM awards
for its efforts in employer branding through talent management at work health
management at work and excellence in HR through technology
Drawing from its rich past and its equally robust performance in the recent times
BSE will continue to remain an icon in the Indian Capital Market
285 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 days closing price is taken for computation of Index closure
The use of Index Closure Algorithm prevents any intentional manipulation of the
closing index value
286 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 affect the
index values The BSE Index Cell does the day-to-day maintenance of the index
within the broad index policy framework set by the BSE Index Committee The BSE
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 BSE Index Committee comprises
of capital market expert fund managers market participants and members of the BSE
Governing Board
43
287 On-Line Computation of the Index
During trading hours value of the Index is calculated and disseminated on real time
basis This is done automatically on the basis of prices at which trades in Index
constituents are executed
288 Adjustment for Bonus Rights and Newly Issued Capital
SENSEX calculation needs to be adjusted for issue of Bonus or 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 BSE Index Cell the base value is adjusted which is used to alter
market capitalization of the component stocks to arrive at the SENSEX value The
BSE Index Cell keeps a close watch on the events that might affect the index on a
regular basis and carries out daily maintenance of all the 19 Indices
2881 Adjustments for Rights Issues
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 (ex-right) price An offsetting or
proportionate adjustment is then made to the Base Market capitalization
2882 Adjustments for Bonus Issue
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
2883 Other Issues 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
buy-back of shares corporate restructuring etc
44
289 Listing Categories
Before badla was resumed in 1996 there were only two categories of securities listed
on the BSE the specified group of shares comprising The securities in which carry
forward deals were allowed and the cash group shares in which no carry forward deals
were permitted Later it was observed that the facility of carry forward was not being
used in all the 94 scrips in the specified group Hence after badla was resumed the
size of the specified group was reduced to 32 scrips on 3 April 1996 The BSE later
decided to regroup the existing A and B group shares into three categories The BSE
delisted 637 companies for a period of 3 years during 2004-05 for non-compliance of
listing agreements
A Group This group consists of large stock with turnover and high floating stock
with large market capitalization In other words scrips with more liquidity and high
networth are included in this group At present there are 150 scrips in this group
B1 Group This group includes scrips of quality companies with equity above Rs 3
crore with high growth potential and trading frequency No carry forward facility was
allowed in this group in June 2000 there were 1803 scrips in this group
B2 Group Scrips in this group were just like those of B1 but with fortnightly
settlement However in September 1996 the BSE introduced weekly settlement for all
scrips listed on the exchange thus doing away with the distinction between the B1 and
B2 groups On June 2000 there were 3219 scrips in this group
Z Group Subsequently a Z group was introduced in 1999 with scrips of companies
that do not meet the rules regulations and stipulations laid down by the exchange It
is a buyer beware company These are some 300 scrips in the group All Z category
stocks result in delivers
F Group A new Flsquo group pertaining to debt market segment was started with effect
from 9 September 1996
S Group The BSE reduced post-public issue capital base requirement from Rs10
crore to Rs3 crore to attract listing by companies with a smaller capital base It also
45
started a new trading segment small cap stock segment known as the Slsquo segment
Corporate with minimum turnover of an equal amount would be eligible to list scrips
on this segment In addition stocks listed on the regional exchanges would also be
able to list on the lsquoSlsquo segment subject to meeting certain criteria
2810 Base Market capitalization Adjustment
The formula for adjusting the Base Market capitalization is as follows
New Base Market Capitalization (NBMC)
New Market capitalization
NBMC = Old Base Market capitalization x mdashmdashmdashmdashmdashmdashmdashmdashmdashmdashmdash
Old Market capitalization
To illustrate suppose a company issues right shares which increases the market
capitalization of the shares of that company by say Rs100 crores The existing Base
Market capitalization (Old Base Market capitalization) say is Rs2450 crores and the
aggregate market capitalization of all the shares included in the index before the right
issue is made is say Rs4781 crore The New Base Market capitalization will then
be
2450x (4781+100)
_____________________ = Rs250124 crores
4781
This figure of Rs 250124 crore will be used as the Base Market capitalization for
calculating the index number from then onwards till the next base change becomes
necessary
Index Review Frequency
The BSE 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
29 STOCK MARKET INDEX
The stock market index is the most important indices of all as it measures overall
market sentiment through a set of stocks that representative of the market The stock
46
market index is a barometer of the market behavior It reflects direction and indicates
day-to-day fluctuations in stock prices The market index reflects expectations about
the behavior of the economy as a whole It is a precursor of economic cycles The
function of a stock index is to provide investors with information regarding the
average share price in the market An ideal index must represent changes in the prices
of the scrips and reflect price movements of typical shares for better market
representation Stock index is a barometer of a nationlsquos economic health as market
prices reflect expectations about the economylsquos performance Stock indices termed as
leading economic as they indicate what is going to happen in the economy in the
future The returns generated in the stock market are based on future expectations A
good market index incorporates a set of scrips which have high market capitalization
and high liquidity Market capitalization is the sum of the market value of all the
stocks included in the index The market value is derived by multiplying the price of
the share outstanding In other words the bid-ask spread is minimum The index on a
day is calculated as the percentage of the aggregate market value of the set of scrips
incorporated in the index on that day to the average market value of the same scrips
during the base period
291 Definition of an Index
A price index is such as the stock market price of the individual securities in the
market It reflects the overall price or return movements of a group of securities
Movements in an index are determined by sample weighting and computational
procedure Sample is normally generated by random selection or try a non random
selection technique designed to incorporate desired characteristics are used to select
sample shares rather than by completely random selection Major criteria for selection
are market activity due representation to various industrial groups and to major stock
exchanges
292 Global Stock Market Indices
2921 The Dow Jones Industrial averagersquos
It is the most widely watched and quoted index because of its long existence The
Dow has 30 constituents and it follows the methodology of price based weighted
47
Changes to stocks included in the Dow are infrequent three stocks were
addeddropped in 1991 four in 1997 and four in 1999 The addition of Microsoft and
Intel in 1999 was the first inclusion of Nasdaq market stocks to the Dow 30
2922 The Nasdaq composite index
The index is the market capitalization weighted of prices for all the stocks listed in the
Nasdaq stock market The Nasdaq composite began on 8 February 1971 with a base
of 100
2923 The Nasdaq 100 index
Nasdaq 100 comprises the largest computer software and telecom stocks by market
capitalization on the Nasdaq For a company to be included in the Nasdaq 100 it must
have a minimum average trading volume of 100000 shares per day and must have
been trading on a major exchange for at least a year or two
2924 The S amp P 500 index
This index comprises 500 biggest publicly traded companies in the US by market
capitalization Most money managers treat the S amp P 500 as a proxy for the US stock
market The S amp P 500 tries to cover all major areas of US economy To be included a
company must be profitable the prospective company must not be closely hold and
must have a large trading volume for its shares
2925 The FTSE 100
The FTSE 100 consists of the largest 100 companies by full market Value listed on
the London Stock Exchange The FTSE 100 is the benchmark index to indicate the
performance of the European market It is a market capitalization weighted index that
also considers the free float weighted of individual stocks before including them in
the index
2926 The MSCI Indices
Include the MSCIEAFE (Europe Australia and Far East) MSCI Europe MSCI
world MSCI (EMF) and MSCI Pacific Basin Indices
48
The MSCI world Index is a free float adjusted market capitalization index that is
designed to measure global developed market equity performance As of April 2002
the MSCI world Index consisted of the MSCI world Index consisted of the following
23 developed market country indices
Australia Austria Belgium Canada Denmark Finland France Germany Greece
Hong Kong Ireland Italy Japan Netherlands New Zealand Norway Singapore
Portugal Spain Sweden Switzerland United Kingdom and the United States of
America
293 Methodology for Calculating The Index
2931 Price Weighted Index
In this method the price of each stock in the index is summed up which is then
equated to an index starting value An arbitrary date is set as the base and the
Laspeyerlsquos Price Index which measures price changes against a fixed base period
quantity weight is used In case of a stock split the market price of the stock falls and
these results in less weighted in the index The Dow Jones Industrial Average and
Nikkie 225 are price-weighted indices
2932 Equal Weighting
In this method each stocklsquos percentage weight in the index is equal and hence all
stocks have an equal influence on the index movement The value line index at
Kansas City Board of Trade (KCBT) is an equal weighted index
2933 Market Capitalization Weighted
29331 Full Market Capitalization Method
In this method the number of shares outstanding multiplied by the market price of a
companylsquos share determines the scriplsquos weighted in the index The shares with the
highest market capitalization would have a higher weighted and would be most
influential in this type of index Eg S amp P 500 Index in USA and S amp P CNX Nify in
India
49
29332 Modified Capitalization Weighted
This method seeks to limit the influence of the largest stocks in the index which
otherwise would dominate the entire index This method sets a limit on the largest
stock or a group of stocks The NASDAQ 100 Index is calculated by using this
method
294 Free Float Market Capitalization Method
2941 Concept
Free float methodology refers to an index construction methodology that takes in to
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 Strategic holding government 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
All BSE indices with exception of BSE-PSU index have adopted the free-float
methodology
2942 Definition of Free Float
Share holding of investor that would not in the normal course come into the
open market for trading are treated as ―Controlling Strategic Holding and
hence not included in free float specifically the following categories of
holding are generally excluded from the definition of free float
Shares hold by foundersdirectorsacquires which has control element
Shares held by person with ―Controlling Interestlsquo
Shares held by Govt as promoters
50
Holding through the FDI Route
Strategic Stakes by private corporate bodiesindividuals
Equity held by employee welfare trusts
Locked-in-shares and shares which not be sold in the open market in normal
course
2943 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-agrave-Vis an investible
index This enables an apple-to-apple comparison thereby facilitating better
evaluation of performance of active managers
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 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
The free float methodology of index construction is considered to be an industry best
practice and all major index providers like MSCI FTSE SampP 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
51
29441 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 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 055 means that only 55 of the market
capitalization of the company will be considered for index calculation
Table 24 Free-float Bands
Free-Float Free-Float Factor Free-Float Free-Float Factor
gt0 - 5 005 gt50 - 55 055
gt5 - 10 010 gt55 - 60 060
gt10 - 15 015 gt60 - 65 065
gt15 - 20 020 gt65 - 70 070
gt20 - 25 025 gt70 - 75 075
gt25 - 30 030 gt75 - 80 080
gt30 - 35 035 gt80 - 85 085
gt35 - 40 040 gt85 - 90 090
gt40 - 45 045 gt90 - 95 095
gt45 - 50 050 gt95 - 100 100
Source wwwbseindiacom
295 BSE Indices
For the premier stock exchange that pioneered the securities transaction business
in India over a century of experience is a proud achievement A lot has changed since
1875 when 318 persons by paying a then princely amount of Re 1 became members
of what today is called Bombay Stock Exchange Limited (BSE) Over the decades
the stock market in the country has passed through good and bad periods The journey
52
in the 20th century has not been an easy one Till the decade of eighties there was no
measure or scale that could precisely measure the various ups and downs in the Indian
stock market BSE in 1986 came out with a Stock Index-SENSEX- that subsequently
became the barometer of the Indian stock market
The launch of SENSEX in 1986 was later followed up in January 1989 by
introduction of BSE National Index (Base 1983-84 = 100) It comprised 100 stocks
listed at five major stock exchanges in India - Mumbai Calcutta Delhi Ahmadabad
and Madras The BSE National Index was renamed BSE-100 Index from October 14
1996 and since then it is being calculated taking into consideration only the prices of
stocks listed at BSE BSE launched the dollar-linked version of BSE-100 index on
May 22 2006
With a view to provide a better representation of the increasing number of listed
companies larger market capitalization and the new industry sectors BSE launched
on 27th May 1994 two new index series viz the BSE-200 and the DOLLEX-200
Since then BSE has come a long way in attuning itself to the varied needs of
investors and market participants In order to fulfill the need for still broader
segment-specific and sector-specific indices BSE has continuously been increasing
the range of its indices BSE-500 Index and 5 sectorial indices were launched in 1999
In 2001 BSE launched BSE-PSU Index DOLLEX-30 and the countrys first free-
float based index - the BSE TEC Index Over the years BSE shifted all its indices to
the free-float methodology
BSE disseminates information on the Price-Earnings Ratio the Price to Book Value
Ratio and the Dividend Yield Percentage on day-to-day basis of all its major indices
The values of all BSE indices are updated on real time basis during market hours and
displayed through the BOLT system BSE website and news wire agencies
All BSE Indices are reviewed periodically by the BSE Index Committee This
Committee which comprises eminent independent finance professionals frames the
broad policy guidelines for the development and maintenance of all BSE indices The
BSE Index Cell carries out the day-to-day maintenance of all indices and conducts
research on development of new indices
53
2951 BSE-100 Index
A broad-based index the BSE-100 was formerly known as the BSE National index
This Index has 1983-84 as the base year and was launched in 1989 In line with the
shift of the BSE Indices to the globally accepted Free-Float methodology BSE-100
was shifted to Free-Float methodology effective from April 5 2004 The method of
computation of Free-Float index and determination of free-float factors is similar to
the methodology for SENSEX
Table 25 Index Specification
Base Year 1983-84
Base Index Value 100
Date of Launch 3-Jan-89
Method of calculation Launched on full market capitalization
method and effective April 05 2004
calculation method shifted to free-float
market capitalization
Number of scrips 100
Index calculation frequency Real Time
Source wwwbseindiacom
2952 Base Year
The financial year 1983-84 has been chosen as the base year The price stability
during that year and proximity to the index series were the main consideration for
choice of 1983-84 as the base year The base value was fixed at 100 points
2953 Dollex-100
BSE also calculates a dollar-linked version of SENSEX and historical values of this
index are available since its inception
2954 BSE-100 index - Scrip Selection Criteria
The general guidelines for selection of constituents in BSE-100 are as follows
Trading Frequency The scrip should have been traded on 95 of the trading days
54
in the last three months Exceptions can be made for extreme reasons like scrip
suspension etc
Final Rank The scrip should figure in the top 200 companies listed by final rank
The final rank is arrived at by assigning 75 weighted to the rank on the basis of
three-month average full market capitalization and 25 weighted to the liquidity rank
based on three-month average daily turnover amp three-month average impact cost
IndustrySector Representation Scrip selection would generally take into account a
balanced sectorial representation of the listed companies in the universe of BSE
Track Record In the opinion of the BSE Index Committee the company should
have an acceptable track record
210 STOCK MARKET VOLATILITY
2101 Meaning
Volatility is a measure for variation of price of a financial instrument over time
Historic volatility is derived from time series of past market prices An implied
volatility is derived from the market price of a market traded derivative (in particular
an option) Volatility does not measure the direction of price changes merely their
dispersion This is because when calculating standard deviation (or variance) all
differences are squared so that negative and positive differences are combined into
one quantity Two instruments with different volatilities may have the same expected
return but the instrument with higher volatility will have larger swings in values over
a given period of time
For example a lower volatility stock may have an expected (average) return of 7
with annual volatility of 5 This would indicate returns from approximately negative
3 to positive 17 most of the time (19 times out of 20 or 95 via a two standard
deviation rule) A higher volatility stock with the same expected return of 7 but
with annual volatility of 20 would indicate returns from approximately negative
33 to positive 47 most of the time (19 times out of 20 or 95) These estimates
assume a normal distribution in reality stocks are found to be leptokurtotic
55
2102 Terminology used in volatility
Volatility as described here refers to the actual current volatility of a financial
instrument for a specified period (for example 30 days or 90 days) It is the volatility
of a financial instrument based on historical prices over the specified period with the
last observation the most recent price This phrase is used particularly when it is
wished to distinguish between the actual current volatility of an instrument and
actual historical volatility which refers to the volatility of a financial instrument
over a specified period but with the last observation on a date in the past
actual future volatility which refers to the volatility of a financial instrument
over a specified period starting at the current time and ending at a future date
(normally the expiry date of an options)
historical implied volatility which refers to the implied volatility observed from
historical prices of the financial instrument (normally options)
current implied volatility which refers to the implied volatility observed from
current prices of the financial instrument
future implied volatility which refers to the implied volatility observed from
future prices of the financial instrument
For a financial instrument whose price follows a random walk or wiener process the
width of the distribution increases as time increases This is because there is an
increasing profitability that the instruments price will be farther away from the initial
price as time increases However rather than increase linearly the volatility increases
with the square-root of time as time increases because some fluctuations are expected
to cancel each other out so the most likely deviation after twice the time will not be
twice the distance from zero
2103 Usefulness of volatility for Investors
Investors care about volatility for five reasons
1 The wider the swings in an investments price the harder emotionally it is to
not worry
2 Price volatility of a trading instrument can define position sizing in a portfolio
56
3 When certain cash flows from selling a security are needed at a specific future
date higher volatility means a greater chance of a shortfall
4 Higher volatility of returns while saving for retirement results in a wider
distribution of possible final portfolio values
5 Higher volatility of return when retired gives withdrawals a larger permanent
impact on the portfolios value
6 Price volatility presents opportunities to buy assets cheaply and sell when
overpriced
24
Company may be able to attract and retain more highly qualified personnel if
it can offer stock options bonuses or other incentives with a known market
value
The image of company may be improved
Obligations
Company must continue to keep shareholders informed about the companys
business operations financial condition and management incurring additional
costs and new legal obligations
Company may be liable if you do not fulfill these new legal obligations
Company may lose some flexibility in managing your companys affairs
particularly when shareholders must approve your actions
Company public offering will take time and money to accomplish
232 Mobilizing savings for investment
When people draw their savings and invest in shares it leads to a
more rational allocation of resources because funds which could have been
consumed or kept in idle deposits banks are mobilized and redirected to
promote business activity with benefits for several economic sectors such
as agriculture commerce and industry resulting in stronger economic growth and
higher productivity levels of firms
233 Facilitating company growth
The smooth functioning of all these activities facilitates economic growth in that
lower costs and enterprise risks promote the production of goods and services as well
as employment In this way the financial system contributes to increased prosperity
An important aspect of modern financial markets however including the stock
markets is absolute discretion For example American stock markets see more
unrestrained acceptance of any firm than in smaller markets attention must be given to
25
the foreign Companies view acquisitions as an opportunity to expand product lines
increase distribution channels hedge against volatility increase its market share or
acquire other necessary business assets A takeover bid or a merger agreement
through the stock market is one of the simplest and most common ways for a
company to grow by acquisition or fusion
234 Profit sharing
Both casual and professional stock investors through dividends and stock
price increases that may result in capital gains will share in the wealth of profitable
businesses
235 Corporate governance
By having a wide and varied scope of owners companies generally tend to improve
on their management standards and efficiency in order to satisfy the demands of these
shareholders and the more stringent rules for public corporations imposed by public
stock exchanges and the government Consequently it is alleged that public
companies (companies that are owned by shareholders who are members of the
general public and trade shares on public exchanges) tend to have better management
records than privately-held companies (those companies where shares are not publicly
traded often owned by the company founders andor their families and heirs or
otherwise by a small group of investors) However some well-documented cases are
known where it is alleged that there has been considerable slippage in corporate
governance on the part of some public companies The dot-com bubbles in the early
2000s and the subprime mortgage crisis in 2007-08 are classical examples of
corporate mismanagement Companies like Petscom (2000) Enron
Corporation (2001) OneTel (2001) Sunbeam(2001) Webyan (2001) Adelphia
(2002) MCI World Com (2002) Parmalat (2003) American International Group
(2008) Lehman Brothers (2008) and Satyam Computer Service(2009) were among
the most widely scrutinized by the media
26
236 Creating investment opportunities for small investors
As opposed to other businesses that require huge capital outlay investing in shares is
open to both the large and small stock investors because a person buys the number of
shares they can afford Therefore the Stock Exchange provides the opportunity for
small investors to own shares of the same companies as large investors
The liquidity that an exchange provides affords investors the ability to quickly and
easily sell securities This is an attractive feature of investing in stocks compared to
other less liquid investments such as real estate
237 Government capital-raising for development projects
Governments at various levels may decide to borrow money in order to finance
infrastructure projects such as sewage and water treatment works or housing estates
by selling another category of securities known as bonds These bonds can be raised
through the Stock Exchange whereby members of the public buy them thus loaning
money to the government The issuance of such bonds can obviate the need to directly
tax the citizens in order to finance development although by securing such bonds
with the full faith and credit of the government instead of with collateral the result is
that the government must tax the citizens or otherwise raise additional funds to make
any regular coupon payments and refund the principal when the bonds mature
238 Barometer of the economy
Form the history of many countries it has shown that the price of share and other
assets is an important part of the dynamics of economic activity The price of these
assets can influence or be an up and coming economy Many times the stock market is
considered the primary indicator of a countrylsquos economic development and strength
If the stock market is rising it tends to be associated with increased business and
investments and if the stock market if falling associated with deceased business and
investments It can also be observed that share prices also affect the wealth of
households and their consumption At the stock exchange share price rise or fall may
depending largely on market forces and sentiments When the economy is stable or
growing the share prices tense to raise or remain stable but when economic face
recession depression or financial crisis result in stock market crash Therefore the
27
movement of share prices and in general of the stock indexes can be an indicator of
the general trend in the economy
24 MAJOR STOCK EXCHANGES
Twenty Major Stock Exchanges Of The World Market Capitalization amp Year-to-date
Total Turnover at the end of August 2009
Table 21 Major Stock Exchanges of World
(August 2009 Figure in Million USD) Region Stock Exchange Market Value
Total Share
Turnovers
America Satildeo Paulo Stock Exchange 103251840 36195900
America Toronto Stock Exchange 143287700 79819310
America New York Stock Exchange 1084200190 1215862060
Asia-Pacific Australian Securities Exchange 106651320 56091280
Asia-Pacific Bombay Stock Exchange 108257200 17117620
Asia-Pacific Hong Kong Stock Exchange 194551770 97022760
Asia-Pacific Korea Exchange 72712530 105047380
Asia-Pacific National Stock Exchange of India 101910900 50665230
Asia-Pacific Shanghai Stock Exchange 214275680 331576850
Asia-Pacific Shenzhen Stock Exchange 59632020 170125680
Asia-Pacific Tokyo Stock Exchange 347860250 267598330
Europe Euro next 260509760 119596220
Europe Frankfurt Stock Exchange (Deutsche Boumlrse) 120429200 158973670
Europe London Stock Exchange 256049110 232151850
Europe Madrid Stock Exchange (Bolsas y Mercados
Espantildeoles)
117852560 104075110
Europe Milan Stock Exchange (Borsa Italiana) 63667480 56575930
Europe Nordic Stock Exchange Group OMX1 78114630 50304990
Europe Swiss Exchange 99235640 52086750
Note includes the Copenhagen Helsinki Iceland Stockholm Tallinn Riga and
Vilnius Stock Exchanges
Sources World Federation of Exchanges - Statistics Monthly
Remarks There are 2 pending major mergers NASDAQ with OMX and London
Stock Exchange with Milan Stock Exchange
28
Chart 23 Market Value
Chart 24 Total Share Turnovers
Source From the table 21
000 400000000 800000000 1200000000
Satildeo Paulo Stock Exchange
Toronto Stock ExchangeNew York Stock Exchange
Australian Securities ExchangeBombay Stock Exchange
Hong Kong Stock ExchangeKorea Exchange
National Stock Exchange of India
Shanghai Stock ExchangeShenzhen Stock Exchange
Tokyo Stock ExchangeEuro next
Frankfurt Stock Exchange (Deutsche Boumlrse)
London Stock ExchangeMadrid Stock Exchange (Bolsas y hellip
Milan Stock Exchange (Borsa Italiana)Nordic Stock Exchange Group OMX1
Swiss Exchange Market hellip
000 500000000 1000000000 1500000000
Satildeo Paulo Stock ExchangeToronto Stock Exchange
New York Stock ExchangeAustralian Securities Exchange
Bombay Stock ExchangeHong Kong Stock Exchange
Korea ExchangeNational Stock Exchange of India
Shanghai Stock ExchangeShenzhen Stock Exchange
Tokyo Stock ExchangeEuro next
Frankfurt Stock Exchange (Deutsche hellipLondon Stock Exchange
Madrid Stock Exchange (Bolsas y hellipMilan Stock Exchange (Borsa Italiana)Nordic Stock Exchange Group OMX1
Swiss Exchange Total Share hellip
29
25 REQUIREMENTS BY STOCK EXCHANGE
Companies have to meet the requirements of the exchange in order to have their
stocks and shares listed and traded there but requirements vary by stock exchanges
251 Bombay Stock Exchange
Bombay Stock Exchange (BSE) has requirements for a minimum market
capitalization of Rs250 Million and minimum public float equivalent to Rs100
Million31
252 London Stock Exchange
The main market of the London Stock Exchange has requirements for a minimum
market capitalization (pound700000) three years of audited financial statements
minimum public float (25 per cent) and sufficient working capital for at least 12
months from the date of listing
253 NASDAQ Stock Exchange
To be listed on the NASDAQ a company must have issued at least 125 million shares
of stock worth at least $70 million and must have earned more than $11 million over
the last three years 32
254 New York Stock Exchange
To be listed on the New York Stock Exchange (NYSE) a company must have issued
at least a million shares of stock worth $100 million and must have earned more than
$10 million over the last three years 33
255 Other types of exchanges
In the 19th century exchanges were opened to trade forward
contracts on commodities Exchange traded forward contracts are called futures
contracts These commodity exchanges later started offering future contracts on other
31 wwwbseindiacomaboutabintrobselistsecasp 32 NASDAQ Corporate -NASDAQ Listing Information wwnasdaqcomaboutlisting_informationstm 33 wwwnysecomFramesethtmldisplayPage=listed
30
products such as interest rates and shares as well as Options contracts They are now
generally known as futures exchanges
26 OWNERSHIP
Stock exchanges originated as mutual organizations owned by its member stock
brokers There has been a recent trend for stock exchanges to demutualize where the
members sell their shares in an initial public offering In this way the mutual
organization becomes a corporation with shares that are listed on a stock exchange
Examples are
Australian Securities Exchange (1998) Euro next (merged with New York Stock
Exchange) NASDAQ (2002) The New York Stock Exchange (2005) Bolsas
Mercados Espanoles and the Sao Paulo Stock Exchange (2007) The Shenzhen and
Shanghai stock exchanges can be characterized as quasi-state institutions insofar as
they were created by government bodies in China and their leading personnel are
directly appointed by the China Securities Regulatory Commission
27 HISTORY OF INDIAN STOCK MARKET
The stock exchange in Mumbai is more than 100 years old The origin of the stock
market in India dates back to the end of the eighteenth century when long term
negotiable securities were first issued The real beginning however occurred in the
middle of the nine teeth century after the enactment of the Companies Act in 1850
which introduced the feature of limited liability and generated investor interest in
corporate securities
The Native Share and Stock Brokerslsquo Association now known as the Bombay Stock
Exchange (BSE) was formed in Bombay (now Mumbai) in 1875 This was followed
by the formation of association in Ahmadabad in 1894 Calcutta (now Kolkata) in
1908 and Madras (now Chennai) in 1937 In order to promote the orderly
development of the stock market the central government introduced a comprehensive
legislation called the Securities Contracts (Regulation) Act 1956
31
The Calcutta Stock Exchange (CSE) was the largest stock exchange in India till the
1960s In 1961 there were 1203 listed companies across the various stock exchanges
of the country Of these 576 were listed on the CSE and 297 on the BSE However
during the later half of the 1960s the relative importance of the CSE declined while
that of the BSE increased sharply
One of the oldest stock markets in Asia the Indian Stock Markets have a 200 years
old history
Table 22 Origin of Indian Stock Market
Year Events
18th
Century
East India Company was the dominant institution and by end of the century business in its loan
securities gained full momentum
1830s Business on corporate stocks and shares in Bank and Cotton presses started in Bombay Trading list
by the end of 1839 got broader
1840s Recognition from banks and merchants to about half a dozen brokers
1850s Rapid development of commercial enterprise saw brokerage business attracting more people into
the business
1860s The number of brokers increased to 60
1860-61 The American Civil War broke out which caused a stoppage of cotton supply from United States of
America marking the beginning of the Share Mania in India
1862-63 The number of brokers increased to about 200 to 250
1865 A disastrous slump began at the end of the American Civil War (as an example Bank of Bombay
Share which had touched Rs 2850 could only be sold at Rs 87)
1874 With the rapidly developing share trading business brokers used to gather at a street (now well
known as Dalal Street) for the purpose of transacting business
1875 The Native Share and Stock Brokers Association (also known as The Bombay Stock
Exchange) was established in Bombay
1880s Development of cotton mills industry and set up of many others
1894 Establishment of The Ahmadabad Share and Stock Brokers Association
1880 -
90s
Sharp increase in share prices of jute industries in 1870s was followed by a boom in tea stocks and
coal
1908 The Calcutta Stock Exchange Association was formed
1920 Madras witnessed boom and business at The Madras Stock Exchange was transacted with 100
brokers
1923 When recession followed number of brokers came down to 3 and the Exchange was closed down
32
1934 Establishment of the Lahore Stock Exchange
1936 Merger of the Lahore Stock Exchange with the Punjab Stock Exchange
1937 Re-organization and set up of the Madras Stock Exchange Limited (Pvt) Limited led by
improvement in stock market activities in South India with establishment of new textile mills and
plantation companies
1940 Uttar Pradesh Stock Exchange Limited and Nagpur Stock Exchange Limited was established
1944 Establishment of The Hyderabad Stock Exchange Limited
1947 Delhi Stock and Share Brokers Association Limited and The Delhi Stocks and Shares Exchange
Limited were established and later on merged into The Delhi Stock Exchange Association
Limited
Sources wwwsurfindiacom wwwappuonlinecom
271 Post Independence Scenario
The depression witnessed after the Independence led to closure of a lot of exchanges
in the country Lahore Stock Exchange was closed down after the partition of India
and later on merged with the Delhi Stock Exchange Bangalore Stock Exchange
Limited was registered in 1957 and got recognition only by 1963 Most of the other
Exchanges were in a miserable state till 1957 when they applied for recognition under
Securities Contracts (Regulations) Act 1956 The Exchanges that were recognized
under the Act were
Bombay Calcutta Madras Ahmadabad Delhi Hyderabad Bangalore Indore
272 Many more stock exchanges were established during 1980s
namely
Cochin Stock Exchange (1980)
Uttar Pradesh Stock Exchange Association Limited (at Kanpur 1982)
Pune Stock Exchange Limited (1982)
Ludhiana Stock Exchange Association Limited (1983)
Gauhati Stock Exchange Limited (1984)
Kanara Stock Exchange Limited (at Mangalore 1985)
33
Magadh Stock Exchange Association (at Patna 1986)
Jaipur Stock Exchange Limited (1989)
Bhubaneswar Stock Exchange Association Limited (1989)
Saurashtra Kutch Stock Exchange Limited (at Rajkot 1989)
Vadodara Stock Exchange Limited (at Baroda 1990)
Coimbatore Stock Exchange
Meerut Stock Exchange
At present there are twenty one recognized stock exchanges in India which does not
include the Over The Counter Exchange of India Limited (OTCEI) and the National
Stock Exchange of India Limited (NSEIL)
Government policies during 1980s also played a vital role in the development of the
Indian Stock Markets There was a sharp increase in number of Exchanges listed
companies as well as their capital which is visible from the following table
Table 23 Pattern of Growth of Stock Exchanges
Source SEBI annual report
273 Trading Pattern of the Indian Stock Market
Indian Stock Exchanges allow trading of securities of only those public limited
companies that are listed on the Exchange(s) They are divided into two categories
S
No
As on 31st December 1946 1961 1971 1980 1991 1995 2000 2005
1 No of Stock Exchanges 7 7 8 9 20 22 23 23
2 No of Listed Cos 1125 1203 1599 2265 6229 8593 9413 4731
5 Market value of Capital
of Listed Cos (Cr Rs)
971 1292 2675 6750 110279 478121 6319212 478121
34
Chart 25 Trading Pattern of the Indian Stock Market
Source wwwbseindiacom
274 Types of Transactions
The flowchart below describes the types of transactions that can be carried out on the
Indian stock exchanges
Chart 26 Types of Transactions
Source wwwbseindiacom
Listed Securities of Public limited companies
Specified securities (forward List)
Equity shares of company that are
- Dividend paying
- growth orinted companies
- paid up capital of atleast Rs50 million
- Market capitalisation of atleast Rs100 million
- has more than 20000 shareholders
Non specicied Securities (Cash List)
equity shares of companies not covered in specified securities
Transactions on Indian Stock Exchanges
Spot Delivery Transactions
Forward Transactions
35
Spot Delivery Transactions
Includes transactions that require delivery and payment within stipulated time
period at the time of entering into the contract
This period shall not be more than 14 days following the date of the contract
Forward Transactions
Transactions in which delivery and payment can be extended by further period
of 14 days each
The overall period should not exceed 90 days from the date of contract
Transactions permitted only in case of specified shares
275 Indian stock exchange allows a member broker to perform
following activities
Act as an agent
Buy and sell securities for clients and charge commission for the same
Act as a trader or dealer as a principal
Buy and sell securities on their account and risk
276 Over The Counter Exchange of India (OTCEI)
Traditionally trading in Stock Exchanges in India followed a conventional style
where people used to gather at the Exchange and bids and offers were made by open
outcry This age-old trading mechanism in the Indian stock markets used to create
much functional inefficiency Lack of liquidity and transparency long settlement
periods and benami transactions are a few examples that adversely affected investors
In order to overcome these inefficiencies OTCEI was incorporated in 1990 under the
Companies Act 1956 OTCEI is the first screen based nationwide stock exchange in
India created by Unit Trust of India Industrial Credit and Investment Corporation of
India Industrial Development Bank of India SBI Capital Markets Industrial Finance
Corporation of India General Insurance Corporation and its subsidiaries and Can
Bank Financial Services
36
Chart 27 Securities traded on the OTCEI
Source wwwbseindiacom
Listed Securities
Securities of the companies listed on the OTC
Can be bought or sold at any OTC counter across India
Should not be listed anywhere else
Permitted Securities
Certain securities (Shares and debentures listed on other exchanges)
Unites of Mutual funds can be traded
Initiated Debentures
An equity holding a minimum of one lakh debentures of a particular scrip can
offer them for trading on the OTC
Advantages of OTCEI
Greater liquidity and lesser risk of intermediary charges due to widely spread trading
mechanism across India The screen-based scrip less trading ensures transparency and
accuracy of prices Faster settlement and transfer process as compared to other
exchanges Shorter allotment procedure (in case of a new issue) than other exchanges
277 National Stock Exchange
In order to lift the Indian stock market trading system at par with the international
standards On the basis of the recommendations of high powered Pherwani
Securities teaded on the
OTCEI
Listed Securities
Permitted Securities
Initiated Debentures
37
Committee the National Stock Exchange was incorporated in 1992 by Industrial
Development Bank of India Industrial Credit and Investment Corporation of India
Industrial Finance Corporation of India all Insurance Corporations selected
commercial banks and others
2771 NSE provides exposure to investors in two types of markets
namely
Wholesale debt market
Capital market
Wholesale Debt Market - Similar to money market operations debt market
operations involve institutional investors and corporate bodies entering into
transactions of high value in financial instruments like treasury bills government
securities commercial papers etc
Capital market- A capital market is a market for securities (debt or equity) where
business enterprises and governments can raise long term funds It is defined as a
market in which money is defined as a market in which money is provided for periods
longer than a year34 as the raising of short term funds takes place on other markets
Capital markets may be classified as primary markets and secondary markets In
primary markets new stock or bond issues are sold to investors via a mechanism
known as underwriting In the secondary markets existing securities are sold and
bought among investors or traders usually on a securities exchange over the counter
or elsewhere
278 Trading at NSE amp BSE
Fully automated screen-based trading mechanism
Strictly follows the principle of an order-driven market
Trading members are linked through a communication network
34 Steven M Sheffrin (2003) Economics Principles in action Upper Saddle River Pearson Prentice
Hall
38
This network allows them to execute trade from their offices
The prices at which the buyer and seller are willing to transact will appear on
the screen
When the prices match the transaction will be completed
A confirmation slip will be printed at the office of the trading member
2781 Advantages of trading at NSE amp BSE
Integrated network for trading in stock market of India
Fully automated screen based system that provides higher degree of
transparency
Investors can transact from any part of the country at uniform prices
Greater functional efficiency supported by totally computerized network
28 THE BOMBAY STOCK EXCHANGE
Formerly the Stock Exchange Mumbai popularly called Bombay Stock Exchange
or BSE is the oldest stock exchange in Asia and has the greatest number of listed
companies in the world with 4700 listed as of August 2007 35
It is located at Dalal Street Mumbai India On 31 December 2007 the equity market
capitalization of the BSE was US $ 179 trillion making it the largest stock exchange
in South Asia and the 12th largest in the world
With over 4700 Indian companies list on the stock exchange [10]
and it has a
significant trading volume The BSE SENSEX (SENSITIVE INDEX) also called the
―BSE 30 is a widely used market index in India and Asia Though many other
exchanges exist BSE and the National Stock Exchange of India account for most of
the trading in shares in India
35 World Federation of Exchanges (2007) wwwworld-exchangesorg
39
281 History of the Bombay Stock exchange
Trading in securities has been in vogue in India for a little over 200 years Trading in
securities dates back 1793 most of them being transactions in loan securities of the
East India Company The broking community prospered as there was a rise in prices
which led to a share mania during 1861-65 This bubble burst in 1865 when the
American Civil War ended The brokers realized that investor confidence in the
securities market could be sustained only by organizing themselves into a regulated
body with defined rules and regulations The realization resulted in formation of ―The
Native Share and Stock Brokerslsquo Association which later came to be known as the
Bombay Stock Exchange In 1875 these brokers assembled at a place now called
Dalal Street
The Bombay Stock Exchange is a voluntary nonprofit making association of broker
members It emerged as a premier stock exchange after the 1960 The increased pace
of industrialization caused by the two world wars protection to the domestic industry
and the governmentlsquos fiscal policies aided the growth of new issues which in turn
helped the BSE to prosper The BSE dominated the Indian Capital Market by
accounting for more than 60 per cent of the all Indian turn over
Until 1992 the BSE operated like a closed club of selected members With the
securities scam outburst in 1992 and the SEBI taking over the rains of the Stock
Market the BSE had to bring about changes in its operational policies Until March
1995 the BSE had an open outcry system of trading However when faced with stiff
competition from NSE the countrylsquos first modern computerized and professionally
managed stock exchange set up in 1994 the BSE had to change its system of trading
and operation
On 14 March 1995 the BSE turned to electronic trading whereby brokers trade using
computers This system is known as the BSE On-line Trading System (BOLT)
The introduction of BOLT helped in improving trading volumes significantly
reducing the spread between buy and sell orders better trading in odd lot shares fixed
income instruments and dealings in the renunciation of rights shares
40
In 1995 BOLT was limited to Mumbai whereas the NSE was operating at the
national level As a result the BSE submitted a proposal for allowing installation of
terminals connected to BOLT in centers outside Mumbai After rejecting the proposal
four times on 29 october 1996 the SEBI finally allowed the BSE to use its BOLT
system nationwide Later the BSE set up a central depository system to dematerialize
shares and promote demate Account (trading)
282 Hours of Operation
Beginning of the Day Session 800 to 900
Trading Session 900 to 1530
Position Transfer Session 1530 to 1550
Closing Session 1550 to 1605
Option Exercise Session 1605 to 1635
Margin Session 1635 to 1650
Query Session 1650 to1735
End of Day Session 1735
The hours of operation for the BSE quoted above are stated in terms of the local time
(ie GMT+530) in Mumbai India
BSElsquos normal trading sessions are on all days of the week except Saturdays Sundays
and Holidays declared by the Exchange in advance 36
283 Services of BSE
BSE also had a wide range of services to empower investors and facilitate smooth
transactions These services are as follows
2831 Investor Services
The Dept of investor services redresses grievances of investors BSE was the first
exchange in the country to provide an amount of Rs 1 million towards the investor
36 Asia Technical Analysis with Phil Smith wwwreutersindianet
41
protection fund it is an amount higher than that of any exchange in the country BSE
launched a nationwide investor awareness program ―Safe Investing in the Stock
Market under which 264 programmers were held in more than 200 cities
2832 The BSE Online Trading (BOLT)
BSE on line Trading (BOLT) facilities on-line screen based trading in securities
BOLT is currently operating in 25000 trader work stations located across over 399
cities in India
2833 BSEWEBXcom
In February 2001 BSE introduced the worldlsquos first centralized exchange based
Internet trading system BSEWEBXcom This initiative enables investors anywhere
in the world to trade on BSE platform
2834 Surveillance
BSElsquos Online Surveillance System (BOSS) monitors on a real time basis the price
movements volume position and real time measurements of the default risk market
reconstruct and generation of cross market alerts
2835 BSE Training Institute
BTI imparts capital market training and certification in collaboration with reputed
management institutes and universities It offers over 40 courses on various aspects of
the capital mark and financial sector More than 20000 people have attended the BTI
program
284 Awards
Fowling awards were given to BSE
The world council of Corporate Governance has awarded the Golden Peacock
Global CSR Award for BSElsquos initiatives in corporate social responsibility
The Annual Reports and Accounts of BSE for the year ended March 312006 and
42
March 312007 have been awarded the ICAI awards for excellence in financial
reporting
The Human Resource Management at BSE has won the Asia-Pacific HRM awards
for its efforts in employer branding through talent management at work health
management at work and excellence in HR through technology
Drawing from its rich past and its equally robust performance in the recent times
BSE will continue to remain an icon in the Indian Capital Market
285 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 days closing price is taken for computation of Index closure
The use of Index Closure Algorithm prevents any intentional manipulation of the
closing index value
286 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 affect the
index values The BSE Index Cell does the day-to-day maintenance of the index
within the broad index policy framework set by the BSE Index Committee The BSE
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 BSE Index Committee comprises
of capital market expert fund managers market participants and members of the BSE
Governing Board
43
287 On-Line Computation of the Index
During trading hours value of the Index is calculated and disseminated on real time
basis This is done automatically on the basis of prices at which trades in Index
constituents are executed
288 Adjustment for Bonus Rights and Newly Issued Capital
SENSEX calculation needs to be adjusted for issue of Bonus or 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 BSE Index Cell the base value is adjusted which is used to alter
market capitalization of the component stocks to arrive at the SENSEX value The
BSE Index Cell keeps a close watch on the events that might affect the index on a
regular basis and carries out daily maintenance of all the 19 Indices
2881 Adjustments for Rights Issues
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 (ex-right) price An offsetting or
proportionate adjustment is then made to the Base Market capitalization
2882 Adjustments for Bonus Issue
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
2883 Other Issues 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
buy-back of shares corporate restructuring etc
44
289 Listing Categories
Before badla was resumed in 1996 there were only two categories of securities listed
on the BSE the specified group of shares comprising The securities in which carry
forward deals were allowed and the cash group shares in which no carry forward deals
were permitted Later it was observed that the facility of carry forward was not being
used in all the 94 scrips in the specified group Hence after badla was resumed the
size of the specified group was reduced to 32 scrips on 3 April 1996 The BSE later
decided to regroup the existing A and B group shares into three categories The BSE
delisted 637 companies for a period of 3 years during 2004-05 for non-compliance of
listing agreements
A Group This group consists of large stock with turnover and high floating stock
with large market capitalization In other words scrips with more liquidity and high
networth are included in this group At present there are 150 scrips in this group
B1 Group This group includes scrips of quality companies with equity above Rs 3
crore with high growth potential and trading frequency No carry forward facility was
allowed in this group in June 2000 there were 1803 scrips in this group
B2 Group Scrips in this group were just like those of B1 but with fortnightly
settlement However in September 1996 the BSE introduced weekly settlement for all
scrips listed on the exchange thus doing away with the distinction between the B1 and
B2 groups On June 2000 there were 3219 scrips in this group
Z Group Subsequently a Z group was introduced in 1999 with scrips of companies
that do not meet the rules regulations and stipulations laid down by the exchange It
is a buyer beware company These are some 300 scrips in the group All Z category
stocks result in delivers
F Group A new Flsquo group pertaining to debt market segment was started with effect
from 9 September 1996
S Group The BSE reduced post-public issue capital base requirement from Rs10
crore to Rs3 crore to attract listing by companies with a smaller capital base It also
45
started a new trading segment small cap stock segment known as the Slsquo segment
Corporate with minimum turnover of an equal amount would be eligible to list scrips
on this segment In addition stocks listed on the regional exchanges would also be
able to list on the lsquoSlsquo segment subject to meeting certain criteria
2810 Base Market capitalization Adjustment
The formula for adjusting the Base Market capitalization is as follows
New Base Market Capitalization (NBMC)
New Market capitalization
NBMC = Old Base Market capitalization x mdashmdashmdashmdashmdashmdashmdashmdashmdashmdashmdash
Old Market capitalization
To illustrate suppose a company issues right shares which increases the market
capitalization of the shares of that company by say Rs100 crores The existing Base
Market capitalization (Old Base Market capitalization) say is Rs2450 crores and the
aggregate market capitalization of all the shares included in the index before the right
issue is made is say Rs4781 crore The New Base Market capitalization will then
be
2450x (4781+100)
_____________________ = Rs250124 crores
4781
This figure of Rs 250124 crore will be used as the Base Market capitalization for
calculating the index number from then onwards till the next base change becomes
necessary
Index Review Frequency
The BSE 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
29 STOCK MARKET INDEX
The stock market index is the most important indices of all as it measures overall
market sentiment through a set of stocks that representative of the market The stock
46
market index is a barometer of the market behavior It reflects direction and indicates
day-to-day fluctuations in stock prices The market index reflects expectations about
the behavior of the economy as a whole It is a precursor of economic cycles The
function of a stock index is to provide investors with information regarding the
average share price in the market An ideal index must represent changes in the prices
of the scrips and reflect price movements of typical shares for better market
representation Stock index is a barometer of a nationlsquos economic health as market
prices reflect expectations about the economylsquos performance Stock indices termed as
leading economic as they indicate what is going to happen in the economy in the
future The returns generated in the stock market are based on future expectations A
good market index incorporates a set of scrips which have high market capitalization
and high liquidity Market capitalization is the sum of the market value of all the
stocks included in the index The market value is derived by multiplying the price of
the share outstanding In other words the bid-ask spread is minimum The index on a
day is calculated as the percentage of the aggregate market value of the set of scrips
incorporated in the index on that day to the average market value of the same scrips
during the base period
291 Definition of an Index
A price index is such as the stock market price of the individual securities in the
market It reflects the overall price or return movements of a group of securities
Movements in an index are determined by sample weighting and computational
procedure Sample is normally generated by random selection or try a non random
selection technique designed to incorporate desired characteristics are used to select
sample shares rather than by completely random selection Major criteria for selection
are market activity due representation to various industrial groups and to major stock
exchanges
292 Global Stock Market Indices
2921 The Dow Jones Industrial averagersquos
It is the most widely watched and quoted index because of its long existence The
Dow has 30 constituents and it follows the methodology of price based weighted
47
Changes to stocks included in the Dow are infrequent three stocks were
addeddropped in 1991 four in 1997 and four in 1999 The addition of Microsoft and
Intel in 1999 was the first inclusion of Nasdaq market stocks to the Dow 30
2922 The Nasdaq composite index
The index is the market capitalization weighted of prices for all the stocks listed in the
Nasdaq stock market The Nasdaq composite began on 8 February 1971 with a base
of 100
2923 The Nasdaq 100 index
Nasdaq 100 comprises the largest computer software and telecom stocks by market
capitalization on the Nasdaq For a company to be included in the Nasdaq 100 it must
have a minimum average trading volume of 100000 shares per day and must have
been trading on a major exchange for at least a year or two
2924 The S amp P 500 index
This index comprises 500 biggest publicly traded companies in the US by market
capitalization Most money managers treat the S amp P 500 as a proxy for the US stock
market The S amp P 500 tries to cover all major areas of US economy To be included a
company must be profitable the prospective company must not be closely hold and
must have a large trading volume for its shares
2925 The FTSE 100
The FTSE 100 consists of the largest 100 companies by full market Value listed on
the London Stock Exchange The FTSE 100 is the benchmark index to indicate the
performance of the European market It is a market capitalization weighted index that
also considers the free float weighted of individual stocks before including them in
the index
2926 The MSCI Indices
Include the MSCIEAFE (Europe Australia and Far East) MSCI Europe MSCI
world MSCI (EMF) and MSCI Pacific Basin Indices
48
The MSCI world Index is a free float adjusted market capitalization index that is
designed to measure global developed market equity performance As of April 2002
the MSCI world Index consisted of the MSCI world Index consisted of the following
23 developed market country indices
Australia Austria Belgium Canada Denmark Finland France Germany Greece
Hong Kong Ireland Italy Japan Netherlands New Zealand Norway Singapore
Portugal Spain Sweden Switzerland United Kingdom and the United States of
America
293 Methodology for Calculating The Index
2931 Price Weighted Index
In this method the price of each stock in the index is summed up which is then
equated to an index starting value An arbitrary date is set as the base and the
Laspeyerlsquos Price Index which measures price changes against a fixed base period
quantity weight is used In case of a stock split the market price of the stock falls and
these results in less weighted in the index The Dow Jones Industrial Average and
Nikkie 225 are price-weighted indices
2932 Equal Weighting
In this method each stocklsquos percentage weight in the index is equal and hence all
stocks have an equal influence on the index movement The value line index at
Kansas City Board of Trade (KCBT) is an equal weighted index
2933 Market Capitalization Weighted
29331 Full Market Capitalization Method
In this method the number of shares outstanding multiplied by the market price of a
companylsquos share determines the scriplsquos weighted in the index The shares with the
highest market capitalization would have a higher weighted and would be most
influential in this type of index Eg S amp P 500 Index in USA and S amp P CNX Nify in
India
49
29332 Modified Capitalization Weighted
This method seeks to limit the influence of the largest stocks in the index which
otherwise would dominate the entire index This method sets a limit on the largest
stock or a group of stocks The NASDAQ 100 Index is calculated by using this
method
294 Free Float Market Capitalization Method
2941 Concept
Free float methodology refers to an index construction methodology that takes in to
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 Strategic holding government 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
All BSE indices with exception of BSE-PSU index have adopted the free-float
methodology
2942 Definition of Free Float
Share holding of investor that would not in the normal course come into the
open market for trading are treated as ―Controlling Strategic Holding and
hence not included in free float specifically the following categories of
holding are generally excluded from the definition of free float
Shares hold by foundersdirectorsacquires which has control element
Shares held by person with ―Controlling Interestlsquo
Shares held by Govt as promoters
50
Holding through the FDI Route
Strategic Stakes by private corporate bodiesindividuals
Equity held by employee welfare trusts
Locked-in-shares and shares which not be sold in the open market in normal
course
2943 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-agrave-Vis an investible
index This enables an apple-to-apple comparison thereby facilitating better
evaluation of performance of active managers
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 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
The free float methodology of index construction is considered to be an industry best
practice and all major index providers like MSCI FTSE SampP 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
51
29441 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 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 055 means that only 55 of the market
capitalization of the company will be considered for index calculation
Table 24 Free-float Bands
Free-Float Free-Float Factor Free-Float Free-Float Factor
gt0 - 5 005 gt50 - 55 055
gt5 - 10 010 gt55 - 60 060
gt10 - 15 015 gt60 - 65 065
gt15 - 20 020 gt65 - 70 070
gt20 - 25 025 gt70 - 75 075
gt25 - 30 030 gt75 - 80 080
gt30 - 35 035 gt80 - 85 085
gt35 - 40 040 gt85 - 90 090
gt40 - 45 045 gt90 - 95 095
gt45 - 50 050 gt95 - 100 100
Source wwwbseindiacom
295 BSE Indices
For the premier stock exchange that pioneered the securities transaction business
in India over a century of experience is a proud achievement A lot has changed since
1875 when 318 persons by paying a then princely amount of Re 1 became members
of what today is called Bombay Stock Exchange Limited (BSE) Over the decades
the stock market in the country has passed through good and bad periods The journey
52
in the 20th century has not been an easy one Till the decade of eighties there was no
measure or scale that could precisely measure the various ups and downs in the Indian
stock market BSE in 1986 came out with a Stock Index-SENSEX- that subsequently
became the barometer of the Indian stock market
The launch of SENSEX in 1986 was later followed up in January 1989 by
introduction of BSE National Index (Base 1983-84 = 100) It comprised 100 stocks
listed at five major stock exchanges in India - Mumbai Calcutta Delhi Ahmadabad
and Madras The BSE National Index was renamed BSE-100 Index from October 14
1996 and since then it is being calculated taking into consideration only the prices of
stocks listed at BSE BSE launched the dollar-linked version of BSE-100 index on
May 22 2006
With a view to provide a better representation of the increasing number of listed
companies larger market capitalization and the new industry sectors BSE launched
on 27th May 1994 two new index series viz the BSE-200 and the DOLLEX-200
Since then BSE has come a long way in attuning itself to the varied needs of
investors and market participants In order to fulfill the need for still broader
segment-specific and sector-specific indices BSE has continuously been increasing
the range of its indices BSE-500 Index and 5 sectorial indices were launched in 1999
In 2001 BSE launched BSE-PSU Index DOLLEX-30 and the countrys first free-
float based index - the BSE TEC Index Over the years BSE shifted all its indices to
the free-float methodology
BSE disseminates information on the Price-Earnings Ratio the Price to Book Value
Ratio and the Dividend Yield Percentage on day-to-day basis of all its major indices
The values of all BSE indices are updated on real time basis during market hours and
displayed through the BOLT system BSE website and news wire agencies
All BSE Indices are reviewed periodically by the BSE Index Committee This
Committee which comprises eminent independent finance professionals frames the
broad policy guidelines for the development and maintenance of all BSE indices The
BSE Index Cell carries out the day-to-day maintenance of all indices and conducts
research on development of new indices
53
2951 BSE-100 Index
A broad-based index the BSE-100 was formerly known as the BSE National index
This Index has 1983-84 as the base year and was launched in 1989 In line with the
shift of the BSE Indices to the globally accepted Free-Float methodology BSE-100
was shifted to Free-Float methodology effective from April 5 2004 The method of
computation of Free-Float index and determination of free-float factors is similar to
the methodology for SENSEX
Table 25 Index Specification
Base Year 1983-84
Base Index Value 100
Date of Launch 3-Jan-89
Method of calculation Launched on full market capitalization
method and effective April 05 2004
calculation method shifted to free-float
market capitalization
Number of scrips 100
Index calculation frequency Real Time
Source wwwbseindiacom
2952 Base Year
The financial year 1983-84 has been chosen as the base year The price stability
during that year and proximity to the index series were the main consideration for
choice of 1983-84 as the base year The base value was fixed at 100 points
2953 Dollex-100
BSE also calculates a dollar-linked version of SENSEX and historical values of this
index are available since its inception
2954 BSE-100 index - Scrip Selection Criteria
The general guidelines for selection of constituents in BSE-100 are as follows
Trading Frequency The scrip should have been traded on 95 of the trading days
54
in the last three months Exceptions can be made for extreme reasons like scrip
suspension etc
Final Rank The scrip should figure in the top 200 companies listed by final rank
The final rank is arrived at by assigning 75 weighted to the rank on the basis of
three-month average full market capitalization and 25 weighted to the liquidity rank
based on three-month average daily turnover amp three-month average impact cost
IndustrySector Representation Scrip selection would generally take into account a
balanced sectorial representation of the listed companies in the universe of BSE
Track Record In the opinion of the BSE Index Committee the company should
have an acceptable track record
210 STOCK MARKET VOLATILITY
2101 Meaning
Volatility is a measure for variation of price of a financial instrument over time
Historic volatility is derived from time series of past market prices An implied
volatility is derived from the market price of a market traded derivative (in particular
an option) Volatility does not measure the direction of price changes merely their
dispersion This is because when calculating standard deviation (or variance) all
differences are squared so that negative and positive differences are combined into
one quantity Two instruments with different volatilities may have the same expected
return but the instrument with higher volatility will have larger swings in values over
a given period of time
For example a lower volatility stock may have an expected (average) return of 7
with annual volatility of 5 This would indicate returns from approximately negative
3 to positive 17 most of the time (19 times out of 20 or 95 via a two standard
deviation rule) A higher volatility stock with the same expected return of 7 but
with annual volatility of 20 would indicate returns from approximately negative
33 to positive 47 most of the time (19 times out of 20 or 95) These estimates
assume a normal distribution in reality stocks are found to be leptokurtotic
55
2102 Terminology used in volatility
Volatility as described here refers to the actual current volatility of a financial
instrument for a specified period (for example 30 days or 90 days) It is the volatility
of a financial instrument based on historical prices over the specified period with the
last observation the most recent price This phrase is used particularly when it is
wished to distinguish between the actual current volatility of an instrument and
actual historical volatility which refers to the volatility of a financial instrument
over a specified period but with the last observation on a date in the past
actual future volatility which refers to the volatility of a financial instrument
over a specified period starting at the current time and ending at a future date
(normally the expiry date of an options)
historical implied volatility which refers to the implied volatility observed from
historical prices of the financial instrument (normally options)
current implied volatility which refers to the implied volatility observed from
current prices of the financial instrument
future implied volatility which refers to the implied volatility observed from
future prices of the financial instrument
For a financial instrument whose price follows a random walk or wiener process the
width of the distribution increases as time increases This is because there is an
increasing profitability that the instruments price will be farther away from the initial
price as time increases However rather than increase linearly the volatility increases
with the square-root of time as time increases because some fluctuations are expected
to cancel each other out so the most likely deviation after twice the time will not be
twice the distance from zero
2103 Usefulness of volatility for Investors
Investors care about volatility for five reasons
1 The wider the swings in an investments price the harder emotionally it is to
not worry
2 Price volatility of a trading instrument can define position sizing in a portfolio
56
3 When certain cash flows from selling a security are needed at a specific future
date higher volatility means a greater chance of a shortfall
4 Higher volatility of returns while saving for retirement results in a wider
distribution of possible final portfolio values
5 Higher volatility of return when retired gives withdrawals a larger permanent
impact on the portfolios value
6 Price volatility presents opportunities to buy assets cheaply and sell when
overpriced
25
the foreign Companies view acquisitions as an opportunity to expand product lines
increase distribution channels hedge against volatility increase its market share or
acquire other necessary business assets A takeover bid or a merger agreement
through the stock market is one of the simplest and most common ways for a
company to grow by acquisition or fusion
234 Profit sharing
Both casual and professional stock investors through dividends and stock
price increases that may result in capital gains will share in the wealth of profitable
businesses
235 Corporate governance
By having a wide and varied scope of owners companies generally tend to improve
on their management standards and efficiency in order to satisfy the demands of these
shareholders and the more stringent rules for public corporations imposed by public
stock exchanges and the government Consequently it is alleged that public
companies (companies that are owned by shareholders who are members of the
general public and trade shares on public exchanges) tend to have better management
records than privately-held companies (those companies where shares are not publicly
traded often owned by the company founders andor their families and heirs or
otherwise by a small group of investors) However some well-documented cases are
known where it is alleged that there has been considerable slippage in corporate
governance on the part of some public companies The dot-com bubbles in the early
2000s and the subprime mortgage crisis in 2007-08 are classical examples of
corporate mismanagement Companies like Petscom (2000) Enron
Corporation (2001) OneTel (2001) Sunbeam(2001) Webyan (2001) Adelphia
(2002) MCI World Com (2002) Parmalat (2003) American International Group
(2008) Lehman Brothers (2008) and Satyam Computer Service(2009) were among
the most widely scrutinized by the media
26
236 Creating investment opportunities for small investors
As opposed to other businesses that require huge capital outlay investing in shares is
open to both the large and small stock investors because a person buys the number of
shares they can afford Therefore the Stock Exchange provides the opportunity for
small investors to own shares of the same companies as large investors
The liquidity that an exchange provides affords investors the ability to quickly and
easily sell securities This is an attractive feature of investing in stocks compared to
other less liquid investments such as real estate
237 Government capital-raising for development projects
Governments at various levels may decide to borrow money in order to finance
infrastructure projects such as sewage and water treatment works or housing estates
by selling another category of securities known as bonds These bonds can be raised
through the Stock Exchange whereby members of the public buy them thus loaning
money to the government The issuance of such bonds can obviate the need to directly
tax the citizens in order to finance development although by securing such bonds
with the full faith and credit of the government instead of with collateral the result is
that the government must tax the citizens or otherwise raise additional funds to make
any regular coupon payments and refund the principal when the bonds mature
238 Barometer of the economy
Form the history of many countries it has shown that the price of share and other
assets is an important part of the dynamics of economic activity The price of these
assets can influence or be an up and coming economy Many times the stock market is
considered the primary indicator of a countrylsquos economic development and strength
If the stock market is rising it tends to be associated with increased business and
investments and if the stock market if falling associated with deceased business and
investments It can also be observed that share prices also affect the wealth of
households and their consumption At the stock exchange share price rise or fall may
depending largely on market forces and sentiments When the economy is stable or
growing the share prices tense to raise or remain stable but when economic face
recession depression or financial crisis result in stock market crash Therefore the
27
movement of share prices and in general of the stock indexes can be an indicator of
the general trend in the economy
24 MAJOR STOCK EXCHANGES
Twenty Major Stock Exchanges Of The World Market Capitalization amp Year-to-date
Total Turnover at the end of August 2009
Table 21 Major Stock Exchanges of World
(August 2009 Figure in Million USD) Region Stock Exchange Market Value
Total Share
Turnovers
America Satildeo Paulo Stock Exchange 103251840 36195900
America Toronto Stock Exchange 143287700 79819310
America New York Stock Exchange 1084200190 1215862060
Asia-Pacific Australian Securities Exchange 106651320 56091280
Asia-Pacific Bombay Stock Exchange 108257200 17117620
Asia-Pacific Hong Kong Stock Exchange 194551770 97022760
Asia-Pacific Korea Exchange 72712530 105047380
Asia-Pacific National Stock Exchange of India 101910900 50665230
Asia-Pacific Shanghai Stock Exchange 214275680 331576850
Asia-Pacific Shenzhen Stock Exchange 59632020 170125680
Asia-Pacific Tokyo Stock Exchange 347860250 267598330
Europe Euro next 260509760 119596220
Europe Frankfurt Stock Exchange (Deutsche Boumlrse) 120429200 158973670
Europe London Stock Exchange 256049110 232151850
Europe Madrid Stock Exchange (Bolsas y Mercados
Espantildeoles)
117852560 104075110
Europe Milan Stock Exchange (Borsa Italiana) 63667480 56575930
Europe Nordic Stock Exchange Group OMX1 78114630 50304990
Europe Swiss Exchange 99235640 52086750
Note includes the Copenhagen Helsinki Iceland Stockholm Tallinn Riga and
Vilnius Stock Exchanges
Sources World Federation of Exchanges - Statistics Monthly
Remarks There are 2 pending major mergers NASDAQ with OMX and London
Stock Exchange with Milan Stock Exchange
28
Chart 23 Market Value
Chart 24 Total Share Turnovers
Source From the table 21
000 400000000 800000000 1200000000
Satildeo Paulo Stock Exchange
Toronto Stock ExchangeNew York Stock Exchange
Australian Securities ExchangeBombay Stock Exchange
Hong Kong Stock ExchangeKorea Exchange
National Stock Exchange of India
Shanghai Stock ExchangeShenzhen Stock Exchange
Tokyo Stock ExchangeEuro next
Frankfurt Stock Exchange (Deutsche Boumlrse)
London Stock ExchangeMadrid Stock Exchange (Bolsas y hellip
Milan Stock Exchange (Borsa Italiana)Nordic Stock Exchange Group OMX1
Swiss Exchange Market hellip
000 500000000 1000000000 1500000000
Satildeo Paulo Stock ExchangeToronto Stock Exchange
New York Stock ExchangeAustralian Securities Exchange
Bombay Stock ExchangeHong Kong Stock Exchange
Korea ExchangeNational Stock Exchange of India
Shanghai Stock ExchangeShenzhen Stock Exchange
Tokyo Stock ExchangeEuro next
Frankfurt Stock Exchange (Deutsche hellipLondon Stock Exchange
Madrid Stock Exchange (Bolsas y hellipMilan Stock Exchange (Borsa Italiana)Nordic Stock Exchange Group OMX1
Swiss Exchange Total Share hellip
29
25 REQUIREMENTS BY STOCK EXCHANGE
Companies have to meet the requirements of the exchange in order to have their
stocks and shares listed and traded there but requirements vary by stock exchanges
251 Bombay Stock Exchange
Bombay Stock Exchange (BSE) has requirements for a minimum market
capitalization of Rs250 Million and minimum public float equivalent to Rs100
Million31
252 London Stock Exchange
The main market of the London Stock Exchange has requirements for a minimum
market capitalization (pound700000) three years of audited financial statements
minimum public float (25 per cent) and sufficient working capital for at least 12
months from the date of listing
253 NASDAQ Stock Exchange
To be listed on the NASDAQ a company must have issued at least 125 million shares
of stock worth at least $70 million and must have earned more than $11 million over
the last three years 32
254 New York Stock Exchange
To be listed on the New York Stock Exchange (NYSE) a company must have issued
at least a million shares of stock worth $100 million and must have earned more than
$10 million over the last three years 33
255 Other types of exchanges
In the 19th century exchanges were opened to trade forward
contracts on commodities Exchange traded forward contracts are called futures
contracts These commodity exchanges later started offering future contracts on other
31 wwwbseindiacomaboutabintrobselistsecasp 32 NASDAQ Corporate -NASDAQ Listing Information wwnasdaqcomaboutlisting_informationstm 33 wwwnysecomFramesethtmldisplayPage=listed
30
products such as interest rates and shares as well as Options contracts They are now
generally known as futures exchanges
26 OWNERSHIP
Stock exchanges originated as mutual organizations owned by its member stock
brokers There has been a recent trend for stock exchanges to demutualize where the
members sell their shares in an initial public offering In this way the mutual
organization becomes a corporation with shares that are listed on a stock exchange
Examples are
Australian Securities Exchange (1998) Euro next (merged with New York Stock
Exchange) NASDAQ (2002) The New York Stock Exchange (2005) Bolsas
Mercados Espanoles and the Sao Paulo Stock Exchange (2007) The Shenzhen and
Shanghai stock exchanges can be characterized as quasi-state institutions insofar as
they were created by government bodies in China and their leading personnel are
directly appointed by the China Securities Regulatory Commission
27 HISTORY OF INDIAN STOCK MARKET
The stock exchange in Mumbai is more than 100 years old The origin of the stock
market in India dates back to the end of the eighteenth century when long term
negotiable securities were first issued The real beginning however occurred in the
middle of the nine teeth century after the enactment of the Companies Act in 1850
which introduced the feature of limited liability and generated investor interest in
corporate securities
The Native Share and Stock Brokerslsquo Association now known as the Bombay Stock
Exchange (BSE) was formed in Bombay (now Mumbai) in 1875 This was followed
by the formation of association in Ahmadabad in 1894 Calcutta (now Kolkata) in
1908 and Madras (now Chennai) in 1937 In order to promote the orderly
development of the stock market the central government introduced a comprehensive
legislation called the Securities Contracts (Regulation) Act 1956
31
The Calcutta Stock Exchange (CSE) was the largest stock exchange in India till the
1960s In 1961 there were 1203 listed companies across the various stock exchanges
of the country Of these 576 were listed on the CSE and 297 on the BSE However
during the later half of the 1960s the relative importance of the CSE declined while
that of the BSE increased sharply
One of the oldest stock markets in Asia the Indian Stock Markets have a 200 years
old history
Table 22 Origin of Indian Stock Market
Year Events
18th
Century
East India Company was the dominant institution and by end of the century business in its loan
securities gained full momentum
1830s Business on corporate stocks and shares in Bank and Cotton presses started in Bombay Trading list
by the end of 1839 got broader
1840s Recognition from banks and merchants to about half a dozen brokers
1850s Rapid development of commercial enterprise saw brokerage business attracting more people into
the business
1860s The number of brokers increased to 60
1860-61 The American Civil War broke out which caused a stoppage of cotton supply from United States of
America marking the beginning of the Share Mania in India
1862-63 The number of brokers increased to about 200 to 250
1865 A disastrous slump began at the end of the American Civil War (as an example Bank of Bombay
Share which had touched Rs 2850 could only be sold at Rs 87)
1874 With the rapidly developing share trading business brokers used to gather at a street (now well
known as Dalal Street) for the purpose of transacting business
1875 The Native Share and Stock Brokers Association (also known as The Bombay Stock
Exchange) was established in Bombay
1880s Development of cotton mills industry and set up of many others
1894 Establishment of The Ahmadabad Share and Stock Brokers Association
1880 -
90s
Sharp increase in share prices of jute industries in 1870s was followed by a boom in tea stocks and
coal
1908 The Calcutta Stock Exchange Association was formed
1920 Madras witnessed boom and business at The Madras Stock Exchange was transacted with 100
brokers
1923 When recession followed number of brokers came down to 3 and the Exchange was closed down
32
1934 Establishment of the Lahore Stock Exchange
1936 Merger of the Lahore Stock Exchange with the Punjab Stock Exchange
1937 Re-organization and set up of the Madras Stock Exchange Limited (Pvt) Limited led by
improvement in stock market activities in South India with establishment of new textile mills and
plantation companies
1940 Uttar Pradesh Stock Exchange Limited and Nagpur Stock Exchange Limited was established
1944 Establishment of The Hyderabad Stock Exchange Limited
1947 Delhi Stock and Share Brokers Association Limited and The Delhi Stocks and Shares Exchange
Limited were established and later on merged into The Delhi Stock Exchange Association
Limited
Sources wwwsurfindiacom wwwappuonlinecom
271 Post Independence Scenario
The depression witnessed after the Independence led to closure of a lot of exchanges
in the country Lahore Stock Exchange was closed down after the partition of India
and later on merged with the Delhi Stock Exchange Bangalore Stock Exchange
Limited was registered in 1957 and got recognition only by 1963 Most of the other
Exchanges were in a miserable state till 1957 when they applied for recognition under
Securities Contracts (Regulations) Act 1956 The Exchanges that were recognized
under the Act were
Bombay Calcutta Madras Ahmadabad Delhi Hyderabad Bangalore Indore
272 Many more stock exchanges were established during 1980s
namely
Cochin Stock Exchange (1980)
Uttar Pradesh Stock Exchange Association Limited (at Kanpur 1982)
Pune Stock Exchange Limited (1982)
Ludhiana Stock Exchange Association Limited (1983)
Gauhati Stock Exchange Limited (1984)
Kanara Stock Exchange Limited (at Mangalore 1985)
33
Magadh Stock Exchange Association (at Patna 1986)
Jaipur Stock Exchange Limited (1989)
Bhubaneswar Stock Exchange Association Limited (1989)
Saurashtra Kutch Stock Exchange Limited (at Rajkot 1989)
Vadodara Stock Exchange Limited (at Baroda 1990)
Coimbatore Stock Exchange
Meerut Stock Exchange
At present there are twenty one recognized stock exchanges in India which does not
include the Over The Counter Exchange of India Limited (OTCEI) and the National
Stock Exchange of India Limited (NSEIL)
Government policies during 1980s also played a vital role in the development of the
Indian Stock Markets There was a sharp increase in number of Exchanges listed
companies as well as their capital which is visible from the following table
Table 23 Pattern of Growth of Stock Exchanges
Source SEBI annual report
273 Trading Pattern of the Indian Stock Market
Indian Stock Exchanges allow trading of securities of only those public limited
companies that are listed on the Exchange(s) They are divided into two categories
S
No
As on 31st December 1946 1961 1971 1980 1991 1995 2000 2005
1 No of Stock Exchanges 7 7 8 9 20 22 23 23
2 No of Listed Cos 1125 1203 1599 2265 6229 8593 9413 4731
5 Market value of Capital
of Listed Cos (Cr Rs)
971 1292 2675 6750 110279 478121 6319212 478121
34
Chart 25 Trading Pattern of the Indian Stock Market
Source wwwbseindiacom
274 Types of Transactions
The flowchart below describes the types of transactions that can be carried out on the
Indian stock exchanges
Chart 26 Types of Transactions
Source wwwbseindiacom
Listed Securities of Public limited companies
Specified securities (forward List)
Equity shares of company that are
- Dividend paying
- growth orinted companies
- paid up capital of atleast Rs50 million
- Market capitalisation of atleast Rs100 million
- has more than 20000 shareholders
Non specicied Securities (Cash List)
equity shares of companies not covered in specified securities
Transactions on Indian Stock Exchanges
Spot Delivery Transactions
Forward Transactions
35
Spot Delivery Transactions
Includes transactions that require delivery and payment within stipulated time
period at the time of entering into the contract
This period shall not be more than 14 days following the date of the contract
Forward Transactions
Transactions in which delivery and payment can be extended by further period
of 14 days each
The overall period should not exceed 90 days from the date of contract
Transactions permitted only in case of specified shares
275 Indian stock exchange allows a member broker to perform
following activities
Act as an agent
Buy and sell securities for clients and charge commission for the same
Act as a trader or dealer as a principal
Buy and sell securities on their account and risk
276 Over The Counter Exchange of India (OTCEI)
Traditionally trading in Stock Exchanges in India followed a conventional style
where people used to gather at the Exchange and bids and offers were made by open
outcry This age-old trading mechanism in the Indian stock markets used to create
much functional inefficiency Lack of liquidity and transparency long settlement
periods and benami transactions are a few examples that adversely affected investors
In order to overcome these inefficiencies OTCEI was incorporated in 1990 under the
Companies Act 1956 OTCEI is the first screen based nationwide stock exchange in
India created by Unit Trust of India Industrial Credit and Investment Corporation of
India Industrial Development Bank of India SBI Capital Markets Industrial Finance
Corporation of India General Insurance Corporation and its subsidiaries and Can
Bank Financial Services
36
Chart 27 Securities traded on the OTCEI
Source wwwbseindiacom
Listed Securities
Securities of the companies listed on the OTC
Can be bought or sold at any OTC counter across India
Should not be listed anywhere else
Permitted Securities
Certain securities (Shares and debentures listed on other exchanges)
Unites of Mutual funds can be traded
Initiated Debentures
An equity holding a minimum of one lakh debentures of a particular scrip can
offer them for trading on the OTC
Advantages of OTCEI
Greater liquidity and lesser risk of intermediary charges due to widely spread trading
mechanism across India The screen-based scrip less trading ensures transparency and
accuracy of prices Faster settlement and transfer process as compared to other
exchanges Shorter allotment procedure (in case of a new issue) than other exchanges
277 National Stock Exchange
In order to lift the Indian stock market trading system at par with the international
standards On the basis of the recommendations of high powered Pherwani
Securities teaded on the
OTCEI
Listed Securities
Permitted Securities
Initiated Debentures
37
Committee the National Stock Exchange was incorporated in 1992 by Industrial
Development Bank of India Industrial Credit and Investment Corporation of India
Industrial Finance Corporation of India all Insurance Corporations selected
commercial banks and others
2771 NSE provides exposure to investors in two types of markets
namely
Wholesale debt market
Capital market
Wholesale Debt Market - Similar to money market operations debt market
operations involve institutional investors and corporate bodies entering into
transactions of high value in financial instruments like treasury bills government
securities commercial papers etc
Capital market- A capital market is a market for securities (debt or equity) where
business enterprises and governments can raise long term funds It is defined as a
market in which money is defined as a market in which money is provided for periods
longer than a year34 as the raising of short term funds takes place on other markets
Capital markets may be classified as primary markets and secondary markets In
primary markets new stock or bond issues are sold to investors via a mechanism
known as underwriting In the secondary markets existing securities are sold and
bought among investors or traders usually on a securities exchange over the counter
or elsewhere
278 Trading at NSE amp BSE
Fully automated screen-based trading mechanism
Strictly follows the principle of an order-driven market
Trading members are linked through a communication network
34 Steven M Sheffrin (2003) Economics Principles in action Upper Saddle River Pearson Prentice
Hall
38
This network allows them to execute trade from their offices
The prices at which the buyer and seller are willing to transact will appear on
the screen
When the prices match the transaction will be completed
A confirmation slip will be printed at the office of the trading member
2781 Advantages of trading at NSE amp BSE
Integrated network for trading in stock market of India
Fully automated screen based system that provides higher degree of
transparency
Investors can transact from any part of the country at uniform prices
Greater functional efficiency supported by totally computerized network
28 THE BOMBAY STOCK EXCHANGE
Formerly the Stock Exchange Mumbai popularly called Bombay Stock Exchange
or BSE is the oldest stock exchange in Asia and has the greatest number of listed
companies in the world with 4700 listed as of August 2007 35
It is located at Dalal Street Mumbai India On 31 December 2007 the equity market
capitalization of the BSE was US $ 179 trillion making it the largest stock exchange
in South Asia and the 12th largest in the world
With over 4700 Indian companies list on the stock exchange [10]
and it has a
significant trading volume The BSE SENSEX (SENSITIVE INDEX) also called the
―BSE 30 is a widely used market index in India and Asia Though many other
exchanges exist BSE and the National Stock Exchange of India account for most of
the trading in shares in India
35 World Federation of Exchanges (2007) wwwworld-exchangesorg
39
281 History of the Bombay Stock exchange
Trading in securities has been in vogue in India for a little over 200 years Trading in
securities dates back 1793 most of them being transactions in loan securities of the
East India Company The broking community prospered as there was a rise in prices
which led to a share mania during 1861-65 This bubble burst in 1865 when the
American Civil War ended The brokers realized that investor confidence in the
securities market could be sustained only by organizing themselves into a regulated
body with defined rules and regulations The realization resulted in formation of ―The
Native Share and Stock Brokerslsquo Association which later came to be known as the
Bombay Stock Exchange In 1875 these brokers assembled at a place now called
Dalal Street
The Bombay Stock Exchange is a voluntary nonprofit making association of broker
members It emerged as a premier stock exchange after the 1960 The increased pace
of industrialization caused by the two world wars protection to the domestic industry
and the governmentlsquos fiscal policies aided the growth of new issues which in turn
helped the BSE to prosper The BSE dominated the Indian Capital Market by
accounting for more than 60 per cent of the all Indian turn over
Until 1992 the BSE operated like a closed club of selected members With the
securities scam outburst in 1992 and the SEBI taking over the rains of the Stock
Market the BSE had to bring about changes in its operational policies Until March
1995 the BSE had an open outcry system of trading However when faced with stiff
competition from NSE the countrylsquos first modern computerized and professionally
managed stock exchange set up in 1994 the BSE had to change its system of trading
and operation
On 14 March 1995 the BSE turned to electronic trading whereby brokers trade using
computers This system is known as the BSE On-line Trading System (BOLT)
The introduction of BOLT helped in improving trading volumes significantly
reducing the spread between buy and sell orders better trading in odd lot shares fixed
income instruments and dealings in the renunciation of rights shares
40
In 1995 BOLT was limited to Mumbai whereas the NSE was operating at the
national level As a result the BSE submitted a proposal for allowing installation of
terminals connected to BOLT in centers outside Mumbai After rejecting the proposal
four times on 29 october 1996 the SEBI finally allowed the BSE to use its BOLT
system nationwide Later the BSE set up a central depository system to dematerialize
shares and promote demate Account (trading)
282 Hours of Operation
Beginning of the Day Session 800 to 900
Trading Session 900 to 1530
Position Transfer Session 1530 to 1550
Closing Session 1550 to 1605
Option Exercise Session 1605 to 1635
Margin Session 1635 to 1650
Query Session 1650 to1735
End of Day Session 1735
The hours of operation for the BSE quoted above are stated in terms of the local time
(ie GMT+530) in Mumbai India
BSElsquos normal trading sessions are on all days of the week except Saturdays Sundays
and Holidays declared by the Exchange in advance 36
283 Services of BSE
BSE also had a wide range of services to empower investors and facilitate smooth
transactions These services are as follows
2831 Investor Services
The Dept of investor services redresses grievances of investors BSE was the first
exchange in the country to provide an amount of Rs 1 million towards the investor
36 Asia Technical Analysis with Phil Smith wwwreutersindianet
41
protection fund it is an amount higher than that of any exchange in the country BSE
launched a nationwide investor awareness program ―Safe Investing in the Stock
Market under which 264 programmers were held in more than 200 cities
2832 The BSE Online Trading (BOLT)
BSE on line Trading (BOLT) facilities on-line screen based trading in securities
BOLT is currently operating in 25000 trader work stations located across over 399
cities in India
2833 BSEWEBXcom
In February 2001 BSE introduced the worldlsquos first centralized exchange based
Internet trading system BSEWEBXcom This initiative enables investors anywhere
in the world to trade on BSE platform
2834 Surveillance
BSElsquos Online Surveillance System (BOSS) monitors on a real time basis the price
movements volume position and real time measurements of the default risk market
reconstruct and generation of cross market alerts
2835 BSE Training Institute
BTI imparts capital market training and certification in collaboration with reputed
management institutes and universities It offers over 40 courses on various aspects of
the capital mark and financial sector More than 20000 people have attended the BTI
program
284 Awards
Fowling awards were given to BSE
The world council of Corporate Governance has awarded the Golden Peacock
Global CSR Award for BSElsquos initiatives in corporate social responsibility
The Annual Reports and Accounts of BSE for the year ended March 312006 and
42
March 312007 have been awarded the ICAI awards for excellence in financial
reporting
The Human Resource Management at BSE has won the Asia-Pacific HRM awards
for its efforts in employer branding through talent management at work health
management at work and excellence in HR through technology
Drawing from its rich past and its equally robust performance in the recent times
BSE will continue to remain an icon in the Indian Capital Market
285 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 days closing price is taken for computation of Index closure
The use of Index Closure Algorithm prevents any intentional manipulation of the
closing index value
286 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 affect the
index values The BSE Index Cell does the day-to-day maintenance of the index
within the broad index policy framework set by the BSE Index Committee The BSE
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 BSE Index Committee comprises
of capital market expert fund managers market participants and members of the BSE
Governing Board
43
287 On-Line Computation of the Index
During trading hours value of the Index is calculated and disseminated on real time
basis This is done automatically on the basis of prices at which trades in Index
constituents are executed
288 Adjustment for Bonus Rights and Newly Issued Capital
SENSEX calculation needs to be adjusted for issue of Bonus or 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 BSE Index Cell the base value is adjusted which is used to alter
market capitalization of the component stocks to arrive at the SENSEX value The
BSE Index Cell keeps a close watch on the events that might affect the index on a
regular basis and carries out daily maintenance of all the 19 Indices
2881 Adjustments for Rights Issues
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 (ex-right) price An offsetting or
proportionate adjustment is then made to the Base Market capitalization
2882 Adjustments for Bonus Issue
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
2883 Other Issues 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
buy-back of shares corporate restructuring etc
44
289 Listing Categories
Before badla was resumed in 1996 there were only two categories of securities listed
on the BSE the specified group of shares comprising The securities in which carry
forward deals were allowed and the cash group shares in which no carry forward deals
were permitted Later it was observed that the facility of carry forward was not being
used in all the 94 scrips in the specified group Hence after badla was resumed the
size of the specified group was reduced to 32 scrips on 3 April 1996 The BSE later
decided to regroup the existing A and B group shares into three categories The BSE
delisted 637 companies for a period of 3 years during 2004-05 for non-compliance of
listing agreements
A Group This group consists of large stock with turnover and high floating stock
with large market capitalization In other words scrips with more liquidity and high
networth are included in this group At present there are 150 scrips in this group
B1 Group This group includes scrips of quality companies with equity above Rs 3
crore with high growth potential and trading frequency No carry forward facility was
allowed in this group in June 2000 there were 1803 scrips in this group
B2 Group Scrips in this group were just like those of B1 but with fortnightly
settlement However in September 1996 the BSE introduced weekly settlement for all
scrips listed on the exchange thus doing away with the distinction between the B1 and
B2 groups On June 2000 there were 3219 scrips in this group
Z Group Subsequently a Z group was introduced in 1999 with scrips of companies
that do not meet the rules regulations and stipulations laid down by the exchange It
is a buyer beware company These are some 300 scrips in the group All Z category
stocks result in delivers
F Group A new Flsquo group pertaining to debt market segment was started with effect
from 9 September 1996
S Group The BSE reduced post-public issue capital base requirement from Rs10
crore to Rs3 crore to attract listing by companies with a smaller capital base It also
45
started a new trading segment small cap stock segment known as the Slsquo segment
Corporate with minimum turnover of an equal amount would be eligible to list scrips
on this segment In addition stocks listed on the regional exchanges would also be
able to list on the lsquoSlsquo segment subject to meeting certain criteria
2810 Base Market capitalization Adjustment
The formula for adjusting the Base Market capitalization is as follows
New Base Market Capitalization (NBMC)
New Market capitalization
NBMC = Old Base Market capitalization x mdashmdashmdashmdashmdashmdashmdashmdashmdashmdashmdash
Old Market capitalization
To illustrate suppose a company issues right shares which increases the market
capitalization of the shares of that company by say Rs100 crores The existing Base
Market capitalization (Old Base Market capitalization) say is Rs2450 crores and the
aggregate market capitalization of all the shares included in the index before the right
issue is made is say Rs4781 crore The New Base Market capitalization will then
be
2450x (4781+100)
_____________________ = Rs250124 crores
4781
This figure of Rs 250124 crore will be used as the Base Market capitalization for
calculating the index number from then onwards till the next base change becomes
necessary
Index Review Frequency
The BSE 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
29 STOCK MARKET INDEX
The stock market index is the most important indices of all as it measures overall
market sentiment through a set of stocks that representative of the market The stock
46
market index is a barometer of the market behavior It reflects direction and indicates
day-to-day fluctuations in stock prices The market index reflects expectations about
the behavior of the economy as a whole It is a precursor of economic cycles The
function of a stock index is to provide investors with information regarding the
average share price in the market An ideal index must represent changes in the prices
of the scrips and reflect price movements of typical shares for better market
representation Stock index is a barometer of a nationlsquos economic health as market
prices reflect expectations about the economylsquos performance Stock indices termed as
leading economic as they indicate what is going to happen in the economy in the
future The returns generated in the stock market are based on future expectations A
good market index incorporates a set of scrips which have high market capitalization
and high liquidity Market capitalization is the sum of the market value of all the
stocks included in the index The market value is derived by multiplying the price of
the share outstanding In other words the bid-ask spread is minimum The index on a
day is calculated as the percentage of the aggregate market value of the set of scrips
incorporated in the index on that day to the average market value of the same scrips
during the base period
291 Definition of an Index
A price index is such as the stock market price of the individual securities in the
market It reflects the overall price or return movements of a group of securities
Movements in an index are determined by sample weighting and computational
procedure Sample is normally generated by random selection or try a non random
selection technique designed to incorporate desired characteristics are used to select
sample shares rather than by completely random selection Major criteria for selection
are market activity due representation to various industrial groups and to major stock
exchanges
292 Global Stock Market Indices
2921 The Dow Jones Industrial averagersquos
It is the most widely watched and quoted index because of its long existence The
Dow has 30 constituents and it follows the methodology of price based weighted
47
Changes to stocks included in the Dow are infrequent three stocks were
addeddropped in 1991 four in 1997 and four in 1999 The addition of Microsoft and
Intel in 1999 was the first inclusion of Nasdaq market stocks to the Dow 30
2922 The Nasdaq composite index
The index is the market capitalization weighted of prices for all the stocks listed in the
Nasdaq stock market The Nasdaq composite began on 8 February 1971 with a base
of 100
2923 The Nasdaq 100 index
Nasdaq 100 comprises the largest computer software and telecom stocks by market
capitalization on the Nasdaq For a company to be included in the Nasdaq 100 it must
have a minimum average trading volume of 100000 shares per day and must have
been trading on a major exchange for at least a year or two
2924 The S amp P 500 index
This index comprises 500 biggest publicly traded companies in the US by market
capitalization Most money managers treat the S amp P 500 as a proxy for the US stock
market The S amp P 500 tries to cover all major areas of US economy To be included a
company must be profitable the prospective company must not be closely hold and
must have a large trading volume for its shares
2925 The FTSE 100
The FTSE 100 consists of the largest 100 companies by full market Value listed on
the London Stock Exchange The FTSE 100 is the benchmark index to indicate the
performance of the European market It is a market capitalization weighted index that
also considers the free float weighted of individual stocks before including them in
the index
2926 The MSCI Indices
Include the MSCIEAFE (Europe Australia and Far East) MSCI Europe MSCI
world MSCI (EMF) and MSCI Pacific Basin Indices
48
The MSCI world Index is a free float adjusted market capitalization index that is
designed to measure global developed market equity performance As of April 2002
the MSCI world Index consisted of the MSCI world Index consisted of the following
23 developed market country indices
Australia Austria Belgium Canada Denmark Finland France Germany Greece
Hong Kong Ireland Italy Japan Netherlands New Zealand Norway Singapore
Portugal Spain Sweden Switzerland United Kingdom and the United States of
America
293 Methodology for Calculating The Index
2931 Price Weighted Index
In this method the price of each stock in the index is summed up which is then
equated to an index starting value An arbitrary date is set as the base and the
Laspeyerlsquos Price Index which measures price changes against a fixed base period
quantity weight is used In case of a stock split the market price of the stock falls and
these results in less weighted in the index The Dow Jones Industrial Average and
Nikkie 225 are price-weighted indices
2932 Equal Weighting
In this method each stocklsquos percentage weight in the index is equal and hence all
stocks have an equal influence on the index movement The value line index at
Kansas City Board of Trade (KCBT) is an equal weighted index
2933 Market Capitalization Weighted
29331 Full Market Capitalization Method
In this method the number of shares outstanding multiplied by the market price of a
companylsquos share determines the scriplsquos weighted in the index The shares with the
highest market capitalization would have a higher weighted and would be most
influential in this type of index Eg S amp P 500 Index in USA and S amp P CNX Nify in
India
49
29332 Modified Capitalization Weighted
This method seeks to limit the influence of the largest stocks in the index which
otherwise would dominate the entire index This method sets a limit on the largest
stock or a group of stocks The NASDAQ 100 Index is calculated by using this
method
294 Free Float Market Capitalization Method
2941 Concept
Free float methodology refers to an index construction methodology that takes in to
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 Strategic holding government 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
All BSE indices with exception of BSE-PSU index have adopted the free-float
methodology
2942 Definition of Free Float
Share holding of investor that would not in the normal course come into the
open market for trading are treated as ―Controlling Strategic Holding and
hence not included in free float specifically the following categories of
holding are generally excluded from the definition of free float
Shares hold by foundersdirectorsacquires which has control element
Shares held by person with ―Controlling Interestlsquo
Shares held by Govt as promoters
50
Holding through the FDI Route
Strategic Stakes by private corporate bodiesindividuals
Equity held by employee welfare trusts
Locked-in-shares and shares which not be sold in the open market in normal
course
2943 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-agrave-Vis an investible
index This enables an apple-to-apple comparison thereby facilitating better
evaluation of performance of active managers
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 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
The free float methodology of index construction is considered to be an industry best
practice and all major index providers like MSCI FTSE SampP 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
51
29441 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 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 055 means that only 55 of the market
capitalization of the company will be considered for index calculation
Table 24 Free-float Bands
Free-Float Free-Float Factor Free-Float Free-Float Factor
gt0 - 5 005 gt50 - 55 055
gt5 - 10 010 gt55 - 60 060
gt10 - 15 015 gt60 - 65 065
gt15 - 20 020 gt65 - 70 070
gt20 - 25 025 gt70 - 75 075
gt25 - 30 030 gt75 - 80 080
gt30 - 35 035 gt80 - 85 085
gt35 - 40 040 gt85 - 90 090
gt40 - 45 045 gt90 - 95 095
gt45 - 50 050 gt95 - 100 100
Source wwwbseindiacom
295 BSE Indices
For the premier stock exchange that pioneered the securities transaction business
in India over a century of experience is a proud achievement A lot has changed since
1875 when 318 persons by paying a then princely amount of Re 1 became members
of what today is called Bombay Stock Exchange Limited (BSE) Over the decades
the stock market in the country has passed through good and bad periods The journey
52
in the 20th century has not been an easy one Till the decade of eighties there was no
measure or scale that could precisely measure the various ups and downs in the Indian
stock market BSE in 1986 came out with a Stock Index-SENSEX- that subsequently
became the barometer of the Indian stock market
The launch of SENSEX in 1986 was later followed up in January 1989 by
introduction of BSE National Index (Base 1983-84 = 100) It comprised 100 stocks
listed at five major stock exchanges in India - Mumbai Calcutta Delhi Ahmadabad
and Madras The BSE National Index was renamed BSE-100 Index from October 14
1996 and since then it is being calculated taking into consideration only the prices of
stocks listed at BSE BSE launched the dollar-linked version of BSE-100 index on
May 22 2006
With a view to provide a better representation of the increasing number of listed
companies larger market capitalization and the new industry sectors BSE launched
on 27th May 1994 two new index series viz the BSE-200 and the DOLLEX-200
Since then BSE has come a long way in attuning itself to the varied needs of
investors and market participants In order to fulfill the need for still broader
segment-specific and sector-specific indices BSE has continuously been increasing
the range of its indices BSE-500 Index and 5 sectorial indices were launched in 1999
In 2001 BSE launched BSE-PSU Index DOLLEX-30 and the countrys first free-
float based index - the BSE TEC Index Over the years BSE shifted all its indices to
the free-float methodology
BSE disseminates information on the Price-Earnings Ratio the Price to Book Value
Ratio and the Dividend Yield Percentage on day-to-day basis of all its major indices
The values of all BSE indices are updated on real time basis during market hours and
displayed through the BOLT system BSE website and news wire agencies
All BSE Indices are reviewed periodically by the BSE Index Committee This
Committee which comprises eminent independent finance professionals frames the
broad policy guidelines for the development and maintenance of all BSE indices The
BSE Index Cell carries out the day-to-day maintenance of all indices and conducts
research on development of new indices
53
2951 BSE-100 Index
A broad-based index the BSE-100 was formerly known as the BSE National index
This Index has 1983-84 as the base year and was launched in 1989 In line with the
shift of the BSE Indices to the globally accepted Free-Float methodology BSE-100
was shifted to Free-Float methodology effective from April 5 2004 The method of
computation of Free-Float index and determination of free-float factors is similar to
the methodology for SENSEX
Table 25 Index Specification
Base Year 1983-84
Base Index Value 100
Date of Launch 3-Jan-89
Method of calculation Launched on full market capitalization
method and effective April 05 2004
calculation method shifted to free-float
market capitalization
Number of scrips 100
Index calculation frequency Real Time
Source wwwbseindiacom
2952 Base Year
The financial year 1983-84 has been chosen as the base year The price stability
during that year and proximity to the index series were the main consideration for
choice of 1983-84 as the base year The base value was fixed at 100 points
2953 Dollex-100
BSE also calculates a dollar-linked version of SENSEX and historical values of this
index are available since its inception
2954 BSE-100 index - Scrip Selection Criteria
The general guidelines for selection of constituents in BSE-100 are as follows
Trading Frequency The scrip should have been traded on 95 of the trading days
54
in the last three months Exceptions can be made for extreme reasons like scrip
suspension etc
Final Rank The scrip should figure in the top 200 companies listed by final rank
The final rank is arrived at by assigning 75 weighted to the rank on the basis of
three-month average full market capitalization and 25 weighted to the liquidity rank
based on three-month average daily turnover amp three-month average impact cost
IndustrySector Representation Scrip selection would generally take into account a
balanced sectorial representation of the listed companies in the universe of BSE
Track Record In the opinion of the BSE Index Committee the company should
have an acceptable track record
210 STOCK MARKET VOLATILITY
2101 Meaning
Volatility is a measure for variation of price of a financial instrument over time
Historic volatility is derived from time series of past market prices An implied
volatility is derived from the market price of a market traded derivative (in particular
an option) Volatility does not measure the direction of price changes merely their
dispersion This is because when calculating standard deviation (or variance) all
differences are squared so that negative and positive differences are combined into
one quantity Two instruments with different volatilities may have the same expected
return but the instrument with higher volatility will have larger swings in values over
a given period of time
For example a lower volatility stock may have an expected (average) return of 7
with annual volatility of 5 This would indicate returns from approximately negative
3 to positive 17 most of the time (19 times out of 20 or 95 via a two standard
deviation rule) A higher volatility stock with the same expected return of 7 but
with annual volatility of 20 would indicate returns from approximately negative
33 to positive 47 most of the time (19 times out of 20 or 95) These estimates
assume a normal distribution in reality stocks are found to be leptokurtotic
55
2102 Terminology used in volatility
Volatility as described here refers to the actual current volatility of a financial
instrument for a specified period (for example 30 days or 90 days) It is the volatility
of a financial instrument based on historical prices over the specified period with the
last observation the most recent price This phrase is used particularly when it is
wished to distinguish between the actual current volatility of an instrument and
actual historical volatility which refers to the volatility of a financial instrument
over a specified period but with the last observation on a date in the past
actual future volatility which refers to the volatility of a financial instrument
over a specified period starting at the current time and ending at a future date
(normally the expiry date of an options)
historical implied volatility which refers to the implied volatility observed from
historical prices of the financial instrument (normally options)
current implied volatility which refers to the implied volatility observed from
current prices of the financial instrument
future implied volatility which refers to the implied volatility observed from
future prices of the financial instrument
For a financial instrument whose price follows a random walk or wiener process the
width of the distribution increases as time increases This is because there is an
increasing profitability that the instruments price will be farther away from the initial
price as time increases However rather than increase linearly the volatility increases
with the square-root of time as time increases because some fluctuations are expected
to cancel each other out so the most likely deviation after twice the time will not be
twice the distance from zero
2103 Usefulness of volatility for Investors
Investors care about volatility for five reasons
1 The wider the swings in an investments price the harder emotionally it is to
not worry
2 Price volatility of a trading instrument can define position sizing in a portfolio
56
3 When certain cash flows from selling a security are needed at a specific future
date higher volatility means a greater chance of a shortfall
4 Higher volatility of returns while saving for retirement results in a wider
distribution of possible final portfolio values
5 Higher volatility of return when retired gives withdrawals a larger permanent
impact on the portfolios value
6 Price volatility presents opportunities to buy assets cheaply and sell when
overpriced
26
236 Creating investment opportunities for small investors
As opposed to other businesses that require huge capital outlay investing in shares is
open to both the large and small stock investors because a person buys the number of
shares they can afford Therefore the Stock Exchange provides the opportunity for
small investors to own shares of the same companies as large investors
The liquidity that an exchange provides affords investors the ability to quickly and
easily sell securities This is an attractive feature of investing in stocks compared to
other less liquid investments such as real estate
237 Government capital-raising for development projects
Governments at various levels may decide to borrow money in order to finance
infrastructure projects such as sewage and water treatment works or housing estates
by selling another category of securities known as bonds These bonds can be raised
through the Stock Exchange whereby members of the public buy them thus loaning
money to the government The issuance of such bonds can obviate the need to directly
tax the citizens in order to finance development although by securing such bonds
with the full faith and credit of the government instead of with collateral the result is
that the government must tax the citizens or otherwise raise additional funds to make
any regular coupon payments and refund the principal when the bonds mature
238 Barometer of the economy
Form the history of many countries it has shown that the price of share and other
assets is an important part of the dynamics of economic activity The price of these
assets can influence or be an up and coming economy Many times the stock market is
considered the primary indicator of a countrylsquos economic development and strength
If the stock market is rising it tends to be associated with increased business and
investments and if the stock market if falling associated with deceased business and
investments It can also be observed that share prices also affect the wealth of
households and their consumption At the stock exchange share price rise or fall may
depending largely on market forces and sentiments When the economy is stable or
growing the share prices tense to raise or remain stable but when economic face
recession depression or financial crisis result in stock market crash Therefore the
27
movement of share prices and in general of the stock indexes can be an indicator of
the general trend in the economy
24 MAJOR STOCK EXCHANGES
Twenty Major Stock Exchanges Of The World Market Capitalization amp Year-to-date
Total Turnover at the end of August 2009
Table 21 Major Stock Exchanges of World
(August 2009 Figure in Million USD) Region Stock Exchange Market Value
Total Share
Turnovers
America Satildeo Paulo Stock Exchange 103251840 36195900
America Toronto Stock Exchange 143287700 79819310
America New York Stock Exchange 1084200190 1215862060
Asia-Pacific Australian Securities Exchange 106651320 56091280
Asia-Pacific Bombay Stock Exchange 108257200 17117620
Asia-Pacific Hong Kong Stock Exchange 194551770 97022760
Asia-Pacific Korea Exchange 72712530 105047380
Asia-Pacific National Stock Exchange of India 101910900 50665230
Asia-Pacific Shanghai Stock Exchange 214275680 331576850
Asia-Pacific Shenzhen Stock Exchange 59632020 170125680
Asia-Pacific Tokyo Stock Exchange 347860250 267598330
Europe Euro next 260509760 119596220
Europe Frankfurt Stock Exchange (Deutsche Boumlrse) 120429200 158973670
Europe London Stock Exchange 256049110 232151850
Europe Madrid Stock Exchange (Bolsas y Mercados
Espantildeoles)
117852560 104075110
Europe Milan Stock Exchange (Borsa Italiana) 63667480 56575930
Europe Nordic Stock Exchange Group OMX1 78114630 50304990
Europe Swiss Exchange 99235640 52086750
Note includes the Copenhagen Helsinki Iceland Stockholm Tallinn Riga and
Vilnius Stock Exchanges
Sources World Federation of Exchanges - Statistics Monthly
Remarks There are 2 pending major mergers NASDAQ with OMX and London
Stock Exchange with Milan Stock Exchange
28
Chart 23 Market Value
Chart 24 Total Share Turnovers
Source From the table 21
000 400000000 800000000 1200000000
Satildeo Paulo Stock Exchange
Toronto Stock ExchangeNew York Stock Exchange
Australian Securities ExchangeBombay Stock Exchange
Hong Kong Stock ExchangeKorea Exchange
National Stock Exchange of India
Shanghai Stock ExchangeShenzhen Stock Exchange
Tokyo Stock ExchangeEuro next
Frankfurt Stock Exchange (Deutsche Boumlrse)
London Stock ExchangeMadrid Stock Exchange (Bolsas y hellip
Milan Stock Exchange (Borsa Italiana)Nordic Stock Exchange Group OMX1
Swiss Exchange Market hellip
000 500000000 1000000000 1500000000
Satildeo Paulo Stock ExchangeToronto Stock Exchange
New York Stock ExchangeAustralian Securities Exchange
Bombay Stock ExchangeHong Kong Stock Exchange
Korea ExchangeNational Stock Exchange of India
Shanghai Stock ExchangeShenzhen Stock Exchange
Tokyo Stock ExchangeEuro next
Frankfurt Stock Exchange (Deutsche hellipLondon Stock Exchange
Madrid Stock Exchange (Bolsas y hellipMilan Stock Exchange (Borsa Italiana)Nordic Stock Exchange Group OMX1
Swiss Exchange Total Share hellip
29
25 REQUIREMENTS BY STOCK EXCHANGE
Companies have to meet the requirements of the exchange in order to have their
stocks and shares listed and traded there but requirements vary by stock exchanges
251 Bombay Stock Exchange
Bombay Stock Exchange (BSE) has requirements for a minimum market
capitalization of Rs250 Million and minimum public float equivalent to Rs100
Million31
252 London Stock Exchange
The main market of the London Stock Exchange has requirements for a minimum
market capitalization (pound700000) three years of audited financial statements
minimum public float (25 per cent) and sufficient working capital for at least 12
months from the date of listing
253 NASDAQ Stock Exchange
To be listed on the NASDAQ a company must have issued at least 125 million shares
of stock worth at least $70 million and must have earned more than $11 million over
the last three years 32
254 New York Stock Exchange
To be listed on the New York Stock Exchange (NYSE) a company must have issued
at least a million shares of stock worth $100 million and must have earned more than
$10 million over the last three years 33
255 Other types of exchanges
In the 19th century exchanges were opened to trade forward
contracts on commodities Exchange traded forward contracts are called futures
contracts These commodity exchanges later started offering future contracts on other
31 wwwbseindiacomaboutabintrobselistsecasp 32 NASDAQ Corporate -NASDAQ Listing Information wwnasdaqcomaboutlisting_informationstm 33 wwwnysecomFramesethtmldisplayPage=listed
30
products such as interest rates and shares as well as Options contracts They are now
generally known as futures exchanges
26 OWNERSHIP
Stock exchanges originated as mutual organizations owned by its member stock
brokers There has been a recent trend for stock exchanges to demutualize where the
members sell their shares in an initial public offering In this way the mutual
organization becomes a corporation with shares that are listed on a stock exchange
Examples are
Australian Securities Exchange (1998) Euro next (merged with New York Stock
Exchange) NASDAQ (2002) The New York Stock Exchange (2005) Bolsas
Mercados Espanoles and the Sao Paulo Stock Exchange (2007) The Shenzhen and
Shanghai stock exchanges can be characterized as quasi-state institutions insofar as
they were created by government bodies in China and their leading personnel are
directly appointed by the China Securities Regulatory Commission
27 HISTORY OF INDIAN STOCK MARKET
The stock exchange in Mumbai is more than 100 years old The origin of the stock
market in India dates back to the end of the eighteenth century when long term
negotiable securities were first issued The real beginning however occurred in the
middle of the nine teeth century after the enactment of the Companies Act in 1850
which introduced the feature of limited liability and generated investor interest in
corporate securities
The Native Share and Stock Brokerslsquo Association now known as the Bombay Stock
Exchange (BSE) was formed in Bombay (now Mumbai) in 1875 This was followed
by the formation of association in Ahmadabad in 1894 Calcutta (now Kolkata) in
1908 and Madras (now Chennai) in 1937 In order to promote the orderly
development of the stock market the central government introduced a comprehensive
legislation called the Securities Contracts (Regulation) Act 1956
31
The Calcutta Stock Exchange (CSE) was the largest stock exchange in India till the
1960s In 1961 there were 1203 listed companies across the various stock exchanges
of the country Of these 576 were listed on the CSE and 297 on the BSE However
during the later half of the 1960s the relative importance of the CSE declined while
that of the BSE increased sharply
One of the oldest stock markets in Asia the Indian Stock Markets have a 200 years
old history
Table 22 Origin of Indian Stock Market
Year Events
18th
Century
East India Company was the dominant institution and by end of the century business in its loan
securities gained full momentum
1830s Business on corporate stocks and shares in Bank and Cotton presses started in Bombay Trading list
by the end of 1839 got broader
1840s Recognition from banks and merchants to about half a dozen brokers
1850s Rapid development of commercial enterprise saw brokerage business attracting more people into
the business
1860s The number of brokers increased to 60
1860-61 The American Civil War broke out which caused a stoppage of cotton supply from United States of
America marking the beginning of the Share Mania in India
1862-63 The number of brokers increased to about 200 to 250
1865 A disastrous slump began at the end of the American Civil War (as an example Bank of Bombay
Share which had touched Rs 2850 could only be sold at Rs 87)
1874 With the rapidly developing share trading business brokers used to gather at a street (now well
known as Dalal Street) for the purpose of transacting business
1875 The Native Share and Stock Brokers Association (also known as The Bombay Stock
Exchange) was established in Bombay
1880s Development of cotton mills industry and set up of many others
1894 Establishment of The Ahmadabad Share and Stock Brokers Association
1880 -
90s
Sharp increase in share prices of jute industries in 1870s was followed by a boom in tea stocks and
coal
1908 The Calcutta Stock Exchange Association was formed
1920 Madras witnessed boom and business at The Madras Stock Exchange was transacted with 100
brokers
1923 When recession followed number of brokers came down to 3 and the Exchange was closed down
32
1934 Establishment of the Lahore Stock Exchange
1936 Merger of the Lahore Stock Exchange with the Punjab Stock Exchange
1937 Re-organization and set up of the Madras Stock Exchange Limited (Pvt) Limited led by
improvement in stock market activities in South India with establishment of new textile mills and
plantation companies
1940 Uttar Pradesh Stock Exchange Limited and Nagpur Stock Exchange Limited was established
1944 Establishment of The Hyderabad Stock Exchange Limited
1947 Delhi Stock and Share Brokers Association Limited and The Delhi Stocks and Shares Exchange
Limited were established and later on merged into The Delhi Stock Exchange Association
Limited
Sources wwwsurfindiacom wwwappuonlinecom
271 Post Independence Scenario
The depression witnessed after the Independence led to closure of a lot of exchanges
in the country Lahore Stock Exchange was closed down after the partition of India
and later on merged with the Delhi Stock Exchange Bangalore Stock Exchange
Limited was registered in 1957 and got recognition only by 1963 Most of the other
Exchanges were in a miserable state till 1957 when they applied for recognition under
Securities Contracts (Regulations) Act 1956 The Exchanges that were recognized
under the Act were
Bombay Calcutta Madras Ahmadabad Delhi Hyderabad Bangalore Indore
272 Many more stock exchanges were established during 1980s
namely
Cochin Stock Exchange (1980)
Uttar Pradesh Stock Exchange Association Limited (at Kanpur 1982)
Pune Stock Exchange Limited (1982)
Ludhiana Stock Exchange Association Limited (1983)
Gauhati Stock Exchange Limited (1984)
Kanara Stock Exchange Limited (at Mangalore 1985)
33
Magadh Stock Exchange Association (at Patna 1986)
Jaipur Stock Exchange Limited (1989)
Bhubaneswar Stock Exchange Association Limited (1989)
Saurashtra Kutch Stock Exchange Limited (at Rajkot 1989)
Vadodara Stock Exchange Limited (at Baroda 1990)
Coimbatore Stock Exchange
Meerut Stock Exchange
At present there are twenty one recognized stock exchanges in India which does not
include the Over The Counter Exchange of India Limited (OTCEI) and the National
Stock Exchange of India Limited (NSEIL)
Government policies during 1980s also played a vital role in the development of the
Indian Stock Markets There was a sharp increase in number of Exchanges listed
companies as well as their capital which is visible from the following table
Table 23 Pattern of Growth of Stock Exchanges
Source SEBI annual report
273 Trading Pattern of the Indian Stock Market
Indian Stock Exchanges allow trading of securities of only those public limited
companies that are listed on the Exchange(s) They are divided into two categories
S
No
As on 31st December 1946 1961 1971 1980 1991 1995 2000 2005
1 No of Stock Exchanges 7 7 8 9 20 22 23 23
2 No of Listed Cos 1125 1203 1599 2265 6229 8593 9413 4731
5 Market value of Capital
of Listed Cos (Cr Rs)
971 1292 2675 6750 110279 478121 6319212 478121
34
Chart 25 Trading Pattern of the Indian Stock Market
Source wwwbseindiacom
274 Types of Transactions
The flowchart below describes the types of transactions that can be carried out on the
Indian stock exchanges
Chart 26 Types of Transactions
Source wwwbseindiacom
Listed Securities of Public limited companies
Specified securities (forward List)
Equity shares of company that are
- Dividend paying
- growth orinted companies
- paid up capital of atleast Rs50 million
- Market capitalisation of atleast Rs100 million
- has more than 20000 shareholders
Non specicied Securities (Cash List)
equity shares of companies not covered in specified securities
Transactions on Indian Stock Exchanges
Spot Delivery Transactions
Forward Transactions
35
Spot Delivery Transactions
Includes transactions that require delivery and payment within stipulated time
period at the time of entering into the contract
This period shall not be more than 14 days following the date of the contract
Forward Transactions
Transactions in which delivery and payment can be extended by further period
of 14 days each
The overall period should not exceed 90 days from the date of contract
Transactions permitted only in case of specified shares
275 Indian stock exchange allows a member broker to perform
following activities
Act as an agent
Buy and sell securities for clients and charge commission for the same
Act as a trader or dealer as a principal
Buy and sell securities on their account and risk
276 Over The Counter Exchange of India (OTCEI)
Traditionally trading in Stock Exchanges in India followed a conventional style
where people used to gather at the Exchange and bids and offers were made by open
outcry This age-old trading mechanism in the Indian stock markets used to create
much functional inefficiency Lack of liquidity and transparency long settlement
periods and benami transactions are a few examples that adversely affected investors
In order to overcome these inefficiencies OTCEI was incorporated in 1990 under the
Companies Act 1956 OTCEI is the first screen based nationwide stock exchange in
India created by Unit Trust of India Industrial Credit and Investment Corporation of
India Industrial Development Bank of India SBI Capital Markets Industrial Finance
Corporation of India General Insurance Corporation and its subsidiaries and Can
Bank Financial Services
36
Chart 27 Securities traded on the OTCEI
Source wwwbseindiacom
Listed Securities
Securities of the companies listed on the OTC
Can be bought or sold at any OTC counter across India
Should not be listed anywhere else
Permitted Securities
Certain securities (Shares and debentures listed on other exchanges)
Unites of Mutual funds can be traded
Initiated Debentures
An equity holding a minimum of one lakh debentures of a particular scrip can
offer them for trading on the OTC
Advantages of OTCEI
Greater liquidity and lesser risk of intermediary charges due to widely spread trading
mechanism across India The screen-based scrip less trading ensures transparency and
accuracy of prices Faster settlement and transfer process as compared to other
exchanges Shorter allotment procedure (in case of a new issue) than other exchanges
277 National Stock Exchange
In order to lift the Indian stock market trading system at par with the international
standards On the basis of the recommendations of high powered Pherwani
Securities teaded on the
OTCEI
Listed Securities
Permitted Securities
Initiated Debentures
37
Committee the National Stock Exchange was incorporated in 1992 by Industrial
Development Bank of India Industrial Credit and Investment Corporation of India
Industrial Finance Corporation of India all Insurance Corporations selected
commercial banks and others
2771 NSE provides exposure to investors in two types of markets
namely
Wholesale debt market
Capital market
Wholesale Debt Market - Similar to money market operations debt market
operations involve institutional investors and corporate bodies entering into
transactions of high value in financial instruments like treasury bills government
securities commercial papers etc
Capital market- A capital market is a market for securities (debt or equity) where
business enterprises and governments can raise long term funds It is defined as a
market in which money is defined as a market in which money is provided for periods
longer than a year34 as the raising of short term funds takes place on other markets
Capital markets may be classified as primary markets and secondary markets In
primary markets new stock or bond issues are sold to investors via a mechanism
known as underwriting In the secondary markets existing securities are sold and
bought among investors or traders usually on a securities exchange over the counter
or elsewhere
278 Trading at NSE amp BSE
Fully automated screen-based trading mechanism
Strictly follows the principle of an order-driven market
Trading members are linked through a communication network
34 Steven M Sheffrin (2003) Economics Principles in action Upper Saddle River Pearson Prentice
Hall
38
This network allows them to execute trade from their offices
The prices at which the buyer and seller are willing to transact will appear on
the screen
When the prices match the transaction will be completed
A confirmation slip will be printed at the office of the trading member
2781 Advantages of trading at NSE amp BSE
Integrated network for trading in stock market of India
Fully automated screen based system that provides higher degree of
transparency
Investors can transact from any part of the country at uniform prices
Greater functional efficiency supported by totally computerized network
28 THE BOMBAY STOCK EXCHANGE
Formerly the Stock Exchange Mumbai popularly called Bombay Stock Exchange
or BSE is the oldest stock exchange in Asia and has the greatest number of listed
companies in the world with 4700 listed as of August 2007 35
It is located at Dalal Street Mumbai India On 31 December 2007 the equity market
capitalization of the BSE was US $ 179 trillion making it the largest stock exchange
in South Asia and the 12th largest in the world
With over 4700 Indian companies list on the stock exchange [10]
and it has a
significant trading volume The BSE SENSEX (SENSITIVE INDEX) also called the
―BSE 30 is a widely used market index in India and Asia Though many other
exchanges exist BSE and the National Stock Exchange of India account for most of
the trading in shares in India
35 World Federation of Exchanges (2007) wwwworld-exchangesorg
39
281 History of the Bombay Stock exchange
Trading in securities has been in vogue in India for a little over 200 years Trading in
securities dates back 1793 most of them being transactions in loan securities of the
East India Company The broking community prospered as there was a rise in prices
which led to a share mania during 1861-65 This bubble burst in 1865 when the
American Civil War ended The brokers realized that investor confidence in the
securities market could be sustained only by organizing themselves into a regulated
body with defined rules and regulations The realization resulted in formation of ―The
Native Share and Stock Brokerslsquo Association which later came to be known as the
Bombay Stock Exchange In 1875 these brokers assembled at a place now called
Dalal Street
The Bombay Stock Exchange is a voluntary nonprofit making association of broker
members It emerged as a premier stock exchange after the 1960 The increased pace
of industrialization caused by the two world wars protection to the domestic industry
and the governmentlsquos fiscal policies aided the growth of new issues which in turn
helped the BSE to prosper The BSE dominated the Indian Capital Market by
accounting for more than 60 per cent of the all Indian turn over
Until 1992 the BSE operated like a closed club of selected members With the
securities scam outburst in 1992 and the SEBI taking over the rains of the Stock
Market the BSE had to bring about changes in its operational policies Until March
1995 the BSE had an open outcry system of trading However when faced with stiff
competition from NSE the countrylsquos first modern computerized and professionally
managed stock exchange set up in 1994 the BSE had to change its system of trading
and operation
On 14 March 1995 the BSE turned to electronic trading whereby brokers trade using
computers This system is known as the BSE On-line Trading System (BOLT)
The introduction of BOLT helped in improving trading volumes significantly
reducing the spread between buy and sell orders better trading in odd lot shares fixed
income instruments and dealings in the renunciation of rights shares
40
In 1995 BOLT was limited to Mumbai whereas the NSE was operating at the
national level As a result the BSE submitted a proposal for allowing installation of
terminals connected to BOLT in centers outside Mumbai After rejecting the proposal
four times on 29 october 1996 the SEBI finally allowed the BSE to use its BOLT
system nationwide Later the BSE set up a central depository system to dematerialize
shares and promote demate Account (trading)
282 Hours of Operation
Beginning of the Day Session 800 to 900
Trading Session 900 to 1530
Position Transfer Session 1530 to 1550
Closing Session 1550 to 1605
Option Exercise Session 1605 to 1635
Margin Session 1635 to 1650
Query Session 1650 to1735
End of Day Session 1735
The hours of operation for the BSE quoted above are stated in terms of the local time
(ie GMT+530) in Mumbai India
BSElsquos normal trading sessions are on all days of the week except Saturdays Sundays
and Holidays declared by the Exchange in advance 36
283 Services of BSE
BSE also had a wide range of services to empower investors and facilitate smooth
transactions These services are as follows
2831 Investor Services
The Dept of investor services redresses grievances of investors BSE was the first
exchange in the country to provide an amount of Rs 1 million towards the investor
36 Asia Technical Analysis with Phil Smith wwwreutersindianet
41
protection fund it is an amount higher than that of any exchange in the country BSE
launched a nationwide investor awareness program ―Safe Investing in the Stock
Market under which 264 programmers were held in more than 200 cities
2832 The BSE Online Trading (BOLT)
BSE on line Trading (BOLT) facilities on-line screen based trading in securities
BOLT is currently operating in 25000 trader work stations located across over 399
cities in India
2833 BSEWEBXcom
In February 2001 BSE introduced the worldlsquos first centralized exchange based
Internet trading system BSEWEBXcom This initiative enables investors anywhere
in the world to trade on BSE platform
2834 Surveillance
BSElsquos Online Surveillance System (BOSS) monitors on a real time basis the price
movements volume position and real time measurements of the default risk market
reconstruct and generation of cross market alerts
2835 BSE Training Institute
BTI imparts capital market training and certification in collaboration with reputed
management institutes and universities It offers over 40 courses on various aspects of
the capital mark and financial sector More than 20000 people have attended the BTI
program
284 Awards
Fowling awards were given to BSE
The world council of Corporate Governance has awarded the Golden Peacock
Global CSR Award for BSElsquos initiatives in corporate social responsibility
The Annual Reports and Accounts of BSE for the year ended March 312006 and
42
March 312007 have been awarded the ICAI awards for excellence in financial
reporting
The Human Resource Management at BSE has won the Asia-Pacific HRM awards
for its efforts in employer branding through talent management at work health
management at work and excellence in HR through technology
Drawing from its rich past and its equally robust performance in the recent times
BSE will continue to remain an icon in the Indian Capital Market
285 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 days closing price is taken for computation of Index closure
The use of Index Closure Algorithm prevents any intentional manipulation of the
closing index value
286 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 affect the
index values The BSE Index Cell does the day-to-day maintenance of the index
within the broad index policy framework set by the BSE Index Committee The BSE
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 BSE Index Committee comprises
of capital market expert fund managers market participants and members of the BSE
Governing Board
43
287 On-Line Computation of the Index
During trading hours value of the Index is calculated and disseminated on real time
basis This is done automatically on the basis of prices at which trades in Index
constituents are executed
288 Adjustment for Bonus Rights and Newly Issued Capital
SENSEX calculation needs to be adjusted for issue of Bonus or 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 BSE Index Cell the base value is adjusted which is used to alter
market capitalization of the component stocks to arrive at the SENSEX value The
BSE Index Cell keeps a close watch on the events that might affect the index on a
regular basis and carries out daily maintenance of all the 19 Indices
2881 Adjustments for Rights Issues
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 (ex-right) price An offsetting or
proportionate adjustment is then made to the Base Market capitalization
2882 Adjustments for Bonus Issue
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
2883 Other Issues 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
buy-back of shares corporate restructuring etc
44
289 Listing Categories
Before badla was resumed in 1996 there were only two categories of securities listed
on the BSE the specified group of shares comprising The securities in which carry
forward deals were allowed and the cash group shares in which no carry forward deals
were permitted Later it was observed that the facility of carry forward was not being
used in all the 94 scrips in the specified group Hence after badla was resumed the
size of the specified group was reduced to 32 scrips on 3 April 1996 The BSE later
decided to regroup the existing A and B group shares into three categories The BSE
delisted 637 companies for a period of 3 years during 2004-05 for non-compliance of
listing agreements
A Group This group consists of large stock with turnover and high floating stock
with large market capitalization In other words scrips with more liquidity and high
networth are included in this group At present there are 150 scrips in this group
B1 Group This group includes scrips of quality companies with equity above Rs 3
crore with high growth potential and trading frequency No carry forward facility was
allowed in this group in June 2000 there were 1803 scrips in this group
B2 Group Scrips in this group were just like those of B1 but with fortnightly
settlement However in September 1996 the BSE introduced weekly settlement for all
scrips listed on the exchange thus doing away with the distinction between the B1 and
B2 groups On June 2000 there were 3219 scrips in this group
Z Group Subsequently a Z group was introduced in 1999 with scrips of companies
that do not meet the rules regulations and stipulations laid down by the exchange It
is a buyer beware company These are some 300 scrips in the group All Z category
stocks result in delivers
F Group A new Flsquo group pertaining to debt market segment was started with effect
from 9 September 1996
S Group The BSE reduced post-public issue capital base requirement from Rs10
crore to Rs3 crore to attract listing by companies with a smaller capital base It also
45
started a new trading segment small cap stock segment known as the Slsquo segment
Corporate with minimum turnover of an equal amount would be eligible to list scrips
on this segment In addition stocks listed on the regional exchanges would also be
able to list on the lsquoSlsquo segment subject to meeting certain criteria
2810 Base Market capitalization Adjustment
The formula for adjusting the Base Market capitalization is as follows
New Base Market Capitalization (NBMC)
New Market capitalization
NBMC = Old Base Market capitalization x mdashmdashmdashmdashmdashmdashmdashmdashmdashmdashmdash
Old Market capitalization
To illustrate suppose a company issues right shares which increases the market
capitalization of the shares of that company by say Rs100 crores The existing Base
Market capitalization (Old Base Market capitalization) say is Rs2450 crores and the
aggregate market capitalization of all the shares included in the index before the right
issue is made is say Rs4781 crore The New Base Market capitalization will then
be
2450x (4781+100)
_____________________ = Rs250124 crores
4781
This figure of Rs 250124 crore will be used as the Base Market capitalization for
calculating the index number from then onwards till the next base change becomes
necessary
Index Review Frequency
The BSE 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
29 STOCK MARKET INDEX
The stock market index is the most important indices of all as it measures overall
market sentiment through a set of stocks that representative of the market The stock
46
market index is a barometer of the market behavior It reflects direction and indicates
day-to-day fluctuations in stock prices The market index reflects expectations about
the behavior of the economy as a whole It is a precursor of economic cycles The
function of a stock index is to provide investors with information regarding the
average share price in the market An ideal index must represent changes in the prices
of the scrips and reflect price movements of typical shares for better market
representation Stock index is a barometer of a nationlsquos economic health as market
prices reflect expectations about the economylsquos performance Stock indices termed as
leading economic as they indicate what is going to happen in the economy in the
future The returns generated in the stock market are based on future expectations A
good market index incorporates a set of scrips which have high market capitalization
and high liquidity Market capitalization is the sum of the market value of all the
stocks included in the index The market value is derived by multiplying the price of
the share outstanding In other words the bid-ask spread is minimum The index on a
day is calculated as the percentage of the aggregate market value of the set of scrips
incorporated in the index on that day to the average market value of the same scrips
during the base period
291 Definition of an Index
A price index is such as the stock market price of the individual securities in the
market It reflects the overall price or return movements of a group of securities
Movements in an index are determined by sample weighting and computational
procedure Sample is normally generated by random selection or try a non random
selection technique designed to incorporate desired characteristics are used to select
sample shares rather than by completely random selection Major criteria for selection
are market activity due representation to various industrial groups and to major stock
exchanges
292 Global Stock Market Indices
2921 The Dow Jones Industrial averagersquos
It is the most widely watched and quoted index because of its long existence The
Dow has 30 constituents and it follows the methodology of price based weighted
47
Changes to stocks included in the Dow are infrequent three stocks were
addeddropped in 1991 four in 1997 and four in 1999 The addition of Microsoft and
Intel in 1999 was the first inclusion of Nasdaq market stocks to the Dow 30
2922 The Nasdaq composite index
The index is the market capitalization weighted of prices for all the stocks listed in the
Nasdaq stock market The Nasdaq composite began on 8 February 1971 with a base
of 100
2923 The Nasdaq 100 index
Nasdaq 100 comprises the largest computer software and telecom stocks by market
capitalization on the Nasdaq For a company to be included in the Nasdaq 100 it must
have a minimum average trading volume of 100000 shares per day and must have
been trading on a major exchange for at least a year or two
2924 The S amp P 500 index
This index comprises 500 biggest publicly traded companies in the US by market
capitalization Most money managers treat the S amp P 500 as a proxy for the US stock
market The S amp P 500 tries to cover all major areas of US economy To be included a
company must be profitable the prospective company must not be closely hold and
must have a large trading volume for its shares
2925 The FTSE 100
The FTSE 100 consists of the largest 100 companies by full market Value listed on
the London Stock Exchange The FTSE 100 is the benchmark index to indicate the
performance of the European market It is a market capitalization weighted index that
also considers the free float weighted of individual stocks before including them in
the index
2926 The MSCI Indices
Include the MSCIEAFE (Europe Australia and Far East) MSCI Europe MSCI
world MSCI (EMF) and MSCI Pacific Basin Indices
48
The MSCI world Index is a free float adjusted market capitalization index that is
designed to measure global developed market equity performance As of April 2002
the MSCI world Index consisted of the MSCI world Index consisted of the following
23 developed market country indices
Australia Austria Belgium Canada Denmark Finland France Germany Greece
Hong Kong Ireland Italy Japan Netherlands New Zealand Norway Singapore
Portugal Spain Sweden Switzerland United Kingdom and the United States of
America
293 Methodology for Calculating The Index
2931 Price Weighted Index
In this method the price of each stock in the index is summed up which is then
equated to an index starting value An arbitrary date is set as the base and the
Laspeyerlsquos Price Index which measures price changes against a fixed base period
quantity weight is used In case of a stock split the market price of the stock falls and
these results in less weighted in the index The Dow Jones Industrial Average and
Nikkie 225 are price-weighted indices
2932 Equal Weighting
In this method each stocklsquos percentage weight in the index is equal and hence all
stocks have an equal influence on the index movement The value line index at
Kansas City Board of Trade (KCBT) is an equal weighted index
2933 Market Capitalization Weighted
29331 Full Market Capitalization Method
In this method the number of shares outstanding multiplied by the market price of a
companylsquos share determines the scriplsquos weighted in the index The shares with the
highest market capitalization would have a higher weighted and would be most
influential in this type of index Eg S amp P 500 Index in USA and S amp P CNX Nify in
India
49
29332 Modified Capitalization Weighted
This method seeks to limit the influence of the largest stocks in the index which
otherwise would dominate the entire index This method sets a limit on the largest
stock or a group of stocks The NASDAQ 100 Index is calculated by using this
method
294 Free Float Market Capitalization Method
2941 Concept
Free float methodology refers to an index construction methodology that takes in to
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 Strategic holding government 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
All BSE indices with exception of BSE-PSU index have adopted the free-float
methodology
2942 Definition of Free Float
Share holding of investor that would not in the normal course come into the
open market for trading are treated as ―Controlling Strategic Holding and
hence not included in free float specifically the following categories of
holding are generally excluded from the definition of free float
Shares hold by foundersdirectorsacquires which has control element
Shares held by person with ―Controlling Interestlsquo
Shares held by Govt as promoters
50
Holding through the FDI Route
Strategic Stakes by private corporate bodiesindividuals
Equity held by employee welfare trusts
Locked-in-shares and shares which not be sold in the open market in normal
course
2943 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-agrave-Vis an investible
index This enables an apple-to-apple comparison thereby facilitating better
evaluation of performance of active managers
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 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
The free float methodology of index construction is considered to be an industry best
practice and all major index providers like MSCI FTSE SampP 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
51
29441 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 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 055 means that only 55 of the market
capitalization of the company will be considered for index calculation
Table 24 Free-float Bands
Free-Float Free-Float Factor Free-Float Free-Float Factor
gt0 - 5 005 gt50 - 55 055
gt5 - 10 010 gt55 - 60 060
gt10 - 15 015 gt60 - 65 065
gt15 - 20 020 gt65 - 70 070
gt20 - 25 025 gt70 - 75 075
gt25 - 30 030 gt75 - 80 080
gt30 - 35 035 gt80 - 85 085
gt35 - 40 040 gt85 - 90 090
gt40 - 45 045 gt90 - 95 095
gt45 - 50 050 gt95 - 100 100
Source wwwbseindiacom
295 BSE Indices
For the premier stock exchange that pioneered the securities transaction business
in India over a century of experience is a proud achievement A lot has changed since
1875 when 318 persons by paying a then princely amount of Re 1 became members
of what today is called Bombay Stock Exchange Limited (BSE) Over the decades
the stock market in the country has passed through good and bad periods The journey
52
in the 20th century has not been an easy one Till the decade of eighties there was no
measure or scale that could precisely measure the various ups and downs in the Indian
stock market BSE in 1986 came out with a Stock Index-SENSEX- that subsequently
became the barometer of the Indian stock market
The launch of SENSEX in 1986 was later followed up in January 1989 by
introduction of BSE National Index (Base 1983-84 = 100) It comprised 100 stocks
listed at five major stock exchanges in India - Mumbai Calcutta Delhi Ahmadabad
and Madras The BSE National Index was renamed BSE-100 Index from October 14
1996 and since then it is being calculated taking into consideration only the prices of
stocks listed at BSE BSE launched the dollar-linked version of BSE-100 index on
May 22 2006
With a view to provide a better representation of the increasing number of listed
companies larger market capitalization and the new industry sectors BSE launched
on 27th May 1994 two new index series viz the BSE-200 and the DOLLEX-200
Since then BSE has come a long way in attuning itself to the varied needs of
investors and market participants In order to fulfill the need for still broader
segment-specific and sector-specific indices BSE has continuously been increasing
the range of its indices BSE-500 Index and 5 sectorial indices were launched in 1999
In 2001 BSE launched BSE-PSU Index DOLLEX-30 and the countrys first free-
float based index - the BSE TEC Index Over the years BSE shifted all its indices to
the free-float methodology
BSE disseminates information on the Price-Earnings Ratio the Price to Book Value
Ratio and the Dividend Yield Percentage on day-to-day basis of all its major indices
The values of all BSE indices are updated on real time basis during market hours and
displayed through the BOLT system BSE website and news wire agencies
All BSE Indices are reviewed periodically by the BSE Index Committee This
Committee which comprises eminent independent finance professionals frames the
broad policy guidelines for the development and maintenance of all BSE indices The
BSE Index Cell carries out the day-to-day maintenance of all indices and conducts
research on development of new indices
53
2951 BSE-100 Index
A broad-based index the BSE-100 was formerly known as the BSE National index
This Index has 1983-84 as the base year and was launched in 1989 In line with the
shift of the BSE Indices to the globally accepted Free-Float methodology BSE-100
was shifted to Free-Float methodology effective from April 5 2004 The method of
computation of Free-Float index and determination of free-float factors is similar to
the methodology for SENSEX
Table 25 Index Specification
Base Year 1983-84
Base Index Value 100
Date of Launch 3-Jan-89
Method of calculation Launched on full market capitalization
method and effective April 05 2004
calculation method shifted to free-float
market capitalization
Number of scrips 100
Index calculation frequency Real Time
Source wwwbseindiacom
2952 Base Year
The financial year 1983-84 has been chosen as the base year The price stability
during that year and proximity to the index series were the main consideration for
choice of 1983-84 as the base year The base value was fixed at 100 points
2953 Dollex-100
BSE also calculates a dollar-linked version of SENSEX and historical values of this
index are available since its inception
2954 BSE-100 index - Scrip Selection Criteria
The general guidelines for selection of constituents in BSE-100 are as follows
Trading Frequency The scrip should have been traded on 95 of the trading days
54
in the last three months Exceptions can be made for extreme reasons like scrip
suspension etc
Final Rank The scrip should figure in the top 200 companies listed by final rank
The final rank is arrived at by assigning 75 weighted to the rank on the basis of
three-month average full market capitalization and 25 weighted to the liquidity rank
based on three-month average daily turnover amp three-month average impact cost
IndustrySector Representation Scrip selection would generally take into account a
balanced sectorial representation of the listed companies in the universe of BSE
Track Record In the opinion of the BSE Index Committee the company should
have an acceptable track record
210 STOCK MARKET VOLATILITY
2101 Meaning
Volatility is a measure for variation of price of a financial instrument over time
Historic volatility is derived from time series of past market prices An implied
volatility is derived from the market price of a market traded derivative (in particular
an option) Volatility does not measure the direction of price changes merely their
dispersion This is because when calculating standard deviation (or variance) all
differences are squared so that negative and positive differences are combined into
one quantity Two instruments with different volatilities may have the same expected
return but the instrument with higher volatility will have larger swings in values over
a given period of time
For example a lower volatility stock may have an expected (average) return of 7
with annual volatility of 5 This would indicate returns from approximately negative
3 to positive 17 most of the time (19 times out of 20 or 95 via a two standard
deviation rule) A higher volatility stock with the same expected return of 7 but
with annual volatility of 20 would indicate returns from approximately negative
33 to positive 47 most of the time (19 times out of 20 or 95) These estimates
assume a normal distribution in reality stocks are found to be leptokurtotic
55
2102 Terminology used in volatility
Volatility as described here refers to the actual current volatility of a financial
instrument for a specified period (for example 30 days or 90 days) It is the volatility
of a financial instrument based on historical prices over the specified period with the
last observation the most recent price This phrase is used particularly when it is
wished to distinguish between the actual current volatility of an instrument and
actual historical volatility which refers to the volatility of a financial instrument
over a specified period but with the last observation on a date in the past
actual future volatility which refers to the volatility of a financial instrument
over a specified period starting at the current time and ending at a future date
(normally the expiry date of an options)
historical implied volatility which refers to the implied volatility observed from
historical prices of the financial instrument (normally options)
current implied volatility which refers to the implied volatility observed from
current prices of the financial instrument
future implied volatility which refers to the implied volatility observed from
future prices of the financial instrument
For a financial instrument whose price follows a random walk or wiener process the
width of the distribution increases as time increases This is because there is an
increasing profitability that the instruments price will be farther away from the initial
price as time increases However rather than increase linearly the volatility increases
with the square-root of time as time increases because some fluctuations are expected
to cancel each other out so the most likely deviation after twice the time will not be
twice the distance from zero
2103 Usefulness of volatility for Investors
Investors care about volatility for five reasons
1 The wider the swings in an investments price the harder emotionally it is to
not worry
2 Price volatility of a trading instrument can define position sizing in a portfolio
56
3 When certain cash flows from selling a security are needed at a specific future
date higher volatility means a greater chance of a shortfall
4 Higher volatility of returns while saving for retirement results in a wider
distribution of possible final portfolio values
5 Higher volatility of return when retired gives withdrawals a larger permanent
impact on the portfolios value
6 Price volatility presents opportunities to buy assets cheaply and sell when
overpriced
27
movement of share prices and in general of the stock indexes can be an indicator of
the general trend in the economy
24 MAJOR STOCK EXCHANGES
Twenty Major Stock Exchanges Of The World Market Capitalization amp Year-to-date
Total Turnover at the end of August 2009
Table 21 Major Stock Exchanges of World
(August 2009 Figure in Million USD) Region Stock Exchange Market Value
Total Share
Turnovers
America Satildeo Paulo Stock Exchange 103251840 36195900
America Toronto Stock Exchange 143287700 79819310
America New York Stock Exchange 1084200190 1215862060
Asia-Pacific Australian Securities Exchange 106651320 56091280
Asia-Pacific Bombay Stock Exchange 108257200 17117620
Asia-Pacific Hong Kong Stock Exchange 194551770 97022760
Asia-Pacific Korea Exchange 72712530 105047380
Asia-Pacific National Stock Exchange of India 101910900 50665230
Asia-Pacific Shanghai Stock Exchange 214275680 331576850
Asia-Pacific Shenzhen Stock Exchange 59632020 170125680
Asia-Pacific Tokyo Stock Exchange 347860250 267598330
Europe Euro next 260509760 119596220
Europe Frankfurt Stock Exchange (Deutsche Boumlrse) 120429200 158973670
Europe London Stock Exchange 256049110 232151850
Europe Madrid Stock Exchange (Bolsas y Mercados
Espantildeoles)
117852560 104075110
Europe Milan Stock Exchange (Borsa Italiana) 63667480 56575930
Europe Nordic Stock Exchange Group OMX1 78114630 50304990
Europe Swiss Exchange 99235640 52086750
Note includes the Copenhagen Helsinki Iceland Stockholm Tallinn Riga and
Vilnius Stock Exchanges
Sources World Federation of Exchanges - Statistics Monthly
Remarks There are 2 pending major mergers NASDAQ with OMX and London
Stock Exchange with Milan Stock Exchange
28
Chart 23 Market Value
Chart 24 Total Share Turnovers
Source From the table 21
000 400000000 800000000 1200000000
Satildeo Paulo Stock Exchange
Toronto Stock ExchangeNew York Stock Exchange
Australian Securities ExchangeBombay Stock Exchange
Hong Kong Stock ExchangeKorea Exchange
National Stock Exchange of India
Shanghai Stock ExchangeShenzhen Stock Exchange
Tokyo Stock ExchangeEuro next
Frankfurt Stock Exchange (Deutsche Boumlrse)
London Stock ExchangeMadrid Stock Exchange (Bolsas y hellip
Milan Stock Exchange (Borsa Italiana)Nordic Stock Exchange Group OMX1
Swiss Exchange Market hellip
000 500000000 1000000000 1500000000
Satildeo Paulo Stock ExchangeToronto Stock Exchange
New York Stock ExchangeAustralian Securities Exchange
Bombay Stock ExchangeHong Kong Stock Exchange
Korea ExchangeNational Stock Exchange of India
Shanghai Stock ExchangeShenzhen Stock Exchange
Tokyo Stock ExchangeEuro next
Frankfurt Stock Exchange (Deutsche hellipLondon Stock Exchange
Madrid Stock Exchange (Bolsas y hellipMilan Stock Exchange (Borsa Italiana)Nordic Stock Exchange Group OMX1
Swiss Exchange Total Share hellip
29
25 REQUIREMENTS BY STOCK EXCHANGE
Companies have to meet the requirements of the exchange in order to have their
stocks and shares listed and traded there but requirements vary by stock exchanges
251 Bombay Stock Exchange
Bombay Stock Exchange (BSE) has requirements for a minimum market
capitalization of Rs250 Million and minimum public float equivalent to Rs100
Million31
252 London Stock Exchange
The main market of the London Stock Exchange has requirements for a minimum
market capitalization (pound700000) three years of audited financial statements
minimum public float (25 per cent) and sufficient working capital for at least 12
months from the date of listing
253 NASDAQ Stock Exchange
To be listed on the NASDAQ a company must have issued at least 125 million shares
of stock worth at least $70 million and must have earned more than $11 million over
the last three years 32
254 New York Stock Exchange
To be listed on the New York Stock Exchange (NYSE) a company must have issued
at least a million shares of stock worth $100 million and must have earned more than
$10 million over the last three years 33
255 Other types of exchanges
In the 19th century exchanges were opened to trade forward
contracts on commodities Exchange traded forward contracts are called futures
contracts These commodity exchanges later started offering future contracts on other
31 wwwbseindiacomaboutabintrobselistsecasp 32 NASDAQ Corporate -NASDAQ Listing Information wwnasdaqcomaboutlisting_informationstm 33 wwwnysecomFramesethtmldisplayPage=listed
30
products such as interest rates and shares as well as Options contracts They are now
generally known as futures exchanges
26 OWNERSHIP
Stock exchanges originated as mutual organizations owned by its member stock
brokers There has been a recent trend for stock exchanges to demutualize where the
members sell their shares in an initial public offering In this way the mutual
organization becomes a corporation with shares that are listed on a stock exchange
Examples are
Australian Securities Exchange (1998) Euro next (merged with New York Stock
Exchange) NASDAQ (2002) The New York Stock Exchange (2005) Bolsas
Mercados Espanoles and the Sao Paulo Stock Exchange (2007) The Shenzhen and
Shanghai stock exchanges can be characterized as quasi-state institutions insofar as
they were created by government bodies in China and their leading personnel are
directly appointed by the China Securities Regulatory Commission
27 HISTORY OF INDIAN STOCK MARKET
The stock exchange in Mumbai is more than 100 years old The origin of the stock
market in India dates back to the end of the eighteenth century when long term
negotiable securities were first issued The real beginning however occurred in the
middle of the nine teeth century after the enactment of the Companies Act in 1850
which introduced the feature of limited liability and generated investor interest in
corporate securities
The Native Share and Stock Brokerslsquo Association now known as the Bombay Stock
Exchange (BSE) was formed in Bombay (now Mumbai) in 1875 This was followed
by the formation of association in Ahmadabad in 1894 Calcutta (now Kolkata) in
1908 and Madras (now Chennai) in 1937 In order to promote the orderly
development of the stock market the central government introduced a comprehensive
legislation called the Securities Contracts (Regulation) Act 1956
31
The Calcutta Stock Exchange (CSE) was the largest stock exchange in India till the
1960s In 1961 there were 1203 listed companies across the various stock exchanges
of the country Of these 576 were listed on the CSE and 297 on the BSE However
during the later half of the 1960s the relative importance of the CSE declined while
that of the BSE increased sharply
One of the oldest stock markets in Asia the Indian Stock Markets have a 200 years
old history
Table 22 Origin of Indian Stock Market
Year Events
18th
Century
East India Company was the dominant institution and by end of the century business in its loan
securities gained full momentum
1830s Business on corporate stocks and shares in Bank and Cotton presses started in Bombay Trading list
by the end of 1839 got broader
1840s Recognition from banks and merchants to about half a dozen brokers
1850s Rapid development of commercial enterprise saw brokerage business attracting more people into
the business
1860s The number of brokers increased to 60
1860-61 The American Civil War broke out which caused a stoppage of cotton supply from United States of
America marking the beginning of the Share Mania in India
1862-63 The number of brokers increased to about 200 to 250
1865 A disastrous slump began at the end of the American Civil War (as an example Bank of Bombay
Share which had touched Rs 2850 could only be sold at Rs 87)
1874 With the rapidly developing share trading business brokers used to gather at a street (now well
known as Dalal Street) for the purpose of transacting business
1875 The Native Share and Stock Brokers Association (also known as The Bombay Stock
Exchange) was established in Bombay
1880s Development of cotton mills industry and set up of many others
1894 Establishment of The Ahmadabad Share and Stock Brokers Association
1880 -
90s
Sharp increase in share prices of jute industries in 1870s was followed by a boom in tea stocks and
coal
1908 The Calcutta Stock Exchange Association was formed
1920 Madras witnessed boom and business at The Madras Stock Exchange was transacted with 100
brokers
1923 When recession followed number of brokers came down to 3 and the Exchange was closed down
32
1934 Establishment of the Lahore Stock Exchange
1936 Merger of the Lahore Stock Exchange with the Punjab Stock Exchange
1937 Re-organization and set up of the Madras Stock Exchange Limited (Pvt) Limited led by
improvement in stock market activities in South India with establishment of new textile mills and
plantation companies
1940 Uttar Pradesh Stock Exchange Limited and Nagpur Stock Exchange Limited was established
1944 Establishment of The Hyderabad Stock Exchange Limited
1947 Delhi Stock and Share Brokers Association Limited and The Delhi Stocks and Shares Exchange
Limited were established and later on merged into The Delhi Stock Exchange Association
Limited
Sources wwwsurfindiacom wwwappuonlinecom
271 Post Independence Scenario
The depression witnessed after the Independence led to closure of a lot of exchanges
in the country Lahore Stock Exchange was closed down after the partition of India
and later on merged with the Delhi Stock Exchange Bangalore Stock Exchange
Limited was registered in 1957 and got recognition only by 1963 Most of the other
Exchanges were in a miserable state till 1957 when they applied for recognition under
Securities Contracts (Regulations) Act 1956 The Exchanges that were recognized
under the Act were
Bombay Calcutta Madras Ahmadabad Delhi Hyderabad Bangalore Indore
272 Many more stock exchanges were established during 1980s
namely
Cochin Stock Exchange (1980)
Uttar Pradesh Stock Exchange Association Limited (at Kanpur 1982)
Pune Stock Exchange Limited (1982)
Ludhiana Stock Exchange Association Limited (1983)
Gauhati Stock Exchange Limited (1984)
Kanara Stock Exchange Limited (at Mangalore 1985)
33
Magadh Stock Exchange Association (at Patna 1986)
Jaipur Stock Exchange Limited (1989)
Bhubaneswar Stock Exchange Association Limited (1989)
Saurashtra Kutch Stock Exchange Limited (at Rajkot 1989)
Vadodara Stock Exchange Limited (at Baroda 1990)
Coimbatore Stock Exchange
Meerut Stock Exchange
At present there are twenty one recognized stock exchanges in India which does not
include the Over The Counter Exchange of India Limited (OTCEI) and the National
Stock Exchange of India Limited (NSEIL)
Government policies during 1980s also played a vital role in the development of the
Indian Stock Markets There was a sharp increase in number of Exchanges listed
companies as well as their capital which is visible from the following table
Table 23 Pattern of Growth of Stock Exchanges
Source SEBI annual report
273 Trading Pattern of the Indian Stock Market
Indian Stock Exchanges allow trading of securities of only those public limited
companies that are listed on the Exchange(s) They are divided into two categories
S
No
As on 31st December 1946 1961 1971 1980 1991 1995 2000 2005
1 No of Stock Exchanges 7 7 8 9 20 22 23 23
2 No of Listed Cos 1125 1203 1599 2265 6229 8593 9413 4731
5 Market value of Capital
of Listed Cos (Cr Rs)
971 1292 2675 6750 110279 478121 6319212 478121
34
Chart 25 Trading Pattern of the Indian Stock Market
Source wwwbseindiacom
274 Types of Transactions
The flowchart below describes the types of transactions that can be carried out on the
Indian stock exchanges
Chart 26 Types of Transactions
Source wwwbseindiacom
Listed Securities of Public limited companies
Specified securities (forward List)
Equity shares of company that are
- Dividend paying
- growth orinted companies
- paid up capital of atleast Rs50 million
- Market capitalisation of atleast Rs100 million
- has more than 20000 shareholders
Non specicied Securities (Cash List)
equity shares of companies not covered in specified securities
Transactions on Indian Stock Exchanges
Spot Delivery Transactions
Forward Transactions
35
Spot Delivery Transactions
Includes transactions that require delivery and payment within stipulated time
period at the time of entering into the contract
This period shall not be more than 14 days following the date of the contract
Forward Transactions
Transactions in which delivery and payment can be extended by further period
of 14 days each
The overall period should not exceed 90 days from the date of contract
Transactions permitted only in case of specified shares
275 Indian stock exchange allows a member broker to perform
following activities
Act as an agent
Buy and sell securities for clients and charge commission for the same
Act as a trader or dealer as a principal
Buy and sell securities on their account and risk
276 Over The Counter Exchange of India (OTCEI)
Traditionally trading in Stock Exchanges in India followed a conventional style
where people used to gather at the Exchange and bids and offers were made by open
outcry This age-old trading mechanism in the Indian stock markets used to create
much functional inefficiency Lack of liquidity and transparency long settlement
periods and benami transactions are a few examples that adversely affected investors
In order to overcome these inefficiencies OTCEI was incorporated in 1990 under the
Companies Act 1956 OTCEI is the first screen based nationwide stock exchange in
India created by Unit Trust of India Industrial Credit and Investment Corporation of
India Industrial Development Bank of India SBI Capital Markets Industrial Finance
Corporation of India General Insurance Corporation and its subsidiaries and Can
Bank Financial Services
36
Chart 27 Securities traded on the OTCEI
Source wwwbseindiacom
Listed Securities
Securities of the companies listed on the OTC
Can be bought or sold at any OTC counter across India
Should not be listed anywhere else
Permitted Securities
Certain securities (Shares and debentures listed on other exchanges)
Unites of Mutual funds can be traded
Initiated Debentures
An equity holding a minimum of one lakh debentures of a particular scrip can
offer them for trading on the OTC
Advantages of OTCEI
Greater liquidity and lesser risk of intermediary charges due to widely spread trading
mechanism across India The screen-based scrip less trading ensures transparency and
accuracy of prices Faster settlement and transfer process as compared to other
exchanges Shorter allotment procedure (in case of a new issue) than other exchanges
277 National Stock Exchange
In order to lift the Indian stock market trading system at par with the international
standards On the basis of the recommendations of high powered Pherwani
Securities teaded on the
OTCEI
Listed Securities
Permitted Securities
Initiated Debentures
37
Committee the National Stock Exchange was incorporated in 1992 by Industrial
Development Bank of India Industrial Credit and Investment Corporation of India
Industrial Finance Corporation of India all Insurance Corporations selected
commercial banks and others
2771 NSE provides exposure to investors in two types of markets
namely
Wholesale debt market
Capital market
Wholesale Debt Market - Similar to money market operations debt market
operations involve institutional investors and corporate bodies entering into
transactions of high value in financial instruments like treasury bills government
securities commercial papers etc
Capital market- A capital market is a market for securities (debt or equity) where
business enterprises and governments can raise long term funds It is defined as a
market in which money is defined as a market in which money is provided for periods
longer than a year34 as the raising of short term funds takes place on other markets
Capital markets may be classified as primary markets and secondary markets In
primary markets new stock or bond issues are sold to investors via a mechanism
known as underwriting In the secondary markets existing securities are sold and
bought among investors or traders usually on a securities exchange over the counter
or elsewhere
278 Trading at NSE amp BSE
Fully automated screen-based trading mechanism
Strictly follows the principle of an order-driven market
Trading members are linked through a communication network
34 Steven M Sheffrin (2003) Economics Principles in action Upper Saddle River Pearson Prentice
Hall
38
This network allows them to execute trade from their offices
The prices at which the buyer and seller are willing to transact will appear on
the screen
When the prices match the transaction will be completed
A confirmation slip will be printed at the office of the trading member
2781 Advantages of trading at NSE amp BSE
Integrated network for trading in stock market of India
Fully automated screen based system that provides higher degree of
transparency
Investors can transact from any part of the country at uniform prices
Greater functional efficiency supported by totally computerized network
28 THE BOMBAY STOCK EXCHANGE
Formerly the Stock Exchange Mumbai popularly called Bombay Stock Exchange
or BSE is the oldest stock exchange in Asia and has the greatest number of listed
companies in the world with 4700 listed as of August 2007 35
It is located at Dalal Street Mumbai India On 31 December 2007 the equity market
capitalization of the BSE was US $ 179 trillion making it the largest stock exchange
in South Asia and the 12th largest in the world
With over 4700 Indian companies list on the stock exchange [10]
and it has a
significant trading volume The BSE SENSEX (SENSITIVE INDEX) also called the
―BSE 30 is a widely used market index in India and Asia Though many other
exchanges exist BSE and the National Stock Exchange of India account for most of
the trading in shares in India
35 World Federation of Exchanges (2007) wwwworld-exchangesorg
39
281 History of the Bombay Stock exchange
Trading in securities has been in vogue in India for a little over 200 years Trading in
securities dates back 1793 most of them being transactions in loan securities of the
East India Company The broking community prospered as there was a rise in prices
which led to a share mania during 1861-65 This bubble burst in 1865 when the
American Civil War ended The brokers realized that investor confidence in the
securities market could be sustained only by organizing themselves into a regulated
body with defined rules and regulations The realization resulted in formation of ―The
Native Share and Stock Brokerslsquo Association which later came to be known as the
Bombay Stock Exchange In 1875 these brokers assembled at a place now called
Dalal Street
The Bombay Stock Exchange is a voluntary nonprofit making association of broker
members It emerged as a premier stock exchange after the 1960 The increased pace
of industrialization caused by the two world wars protection to the domestic industry
and the governmentlsquos fiscal policies aided the growth of new issues which in turn
helped the BSE to prosper The BSE dominated the Indian Capital Market by
accounting for more than 60 per cent of the all Indian turn over
Until 1992 the BSE operated like a closed club of selected members With the
securities scam outburst in 1992 and the SEBI taking over the rains of the Stock
Market the BSE had to bring about changes in its operational policies Until March
1995 the BSE had an open outcry system of trading However when faced with stiff
competition from NSE the countrylsquos first modern computerized and professionally
managed stock exchange set up in 1994 the BSE had to change its system of trading
and operation
On 14 March 1995 the BSE turned to electronic trading whereby brokers trade using
computers This system is known as the BSE On-line Trading System (BOLT)
The introduction of BOLT helped in improving trading volumes significantly
reducing the spread between buy and sell orders better trading in odd lot shares fixed
income instruments and dealings in the renunciation of rights shares
40
In 1995 BOLT was limited to Mumbai whereas the NSE was operating at the
national level As a result the BSE submitted a proposal for allowing installation of
terminals connected to BOLT in centers outside Mumbai After rejecting the proposal
four times on 29 october 1996 the SEBI finally allowed the BSE to use its BOLT
system nationwide Later the BSE set up a central depository system to dematerialize
shares and promote demate Account (trading)
282 Hours of Operation
Beginning of the Day Session 800 to 900
Trading Session 900 to 1530
Position Transfer Session 1530 to 1550
Closing Session 1550 to 1605
Option Exercise Session 1605 to 1635
Margin Session 1635 to 1650
Query Session 1650 to1735
End of Day Session 1735
The hours of operation for the BSE quoted above are stated in terms of the local time
(ie GMT+530) in Mumbai India
BSElsquos normal trading sessions are on all days of the week except Saturdays Sundays
and Holidays declared by the Exchange in advance 36
283 Services of BSE
BSE also had a wide range of services to empower investors and facilitate smooth
transactions These services are as follows
2831 Investor Services
The Dept of investor services redresses grievances of investors BSE was the first
exchange in the country to provide an amount of Rs 1 million towards the investor
36 Asia Technical Analysis with Phil Smith wwwreutersindianet
41
protection fund it is an amount higher than that of any exchange in the country BSE
launched a nationwide investor awareness program ―Safe Investing in the Stock
Market under which 264 programmers were held in more than 200 cities
2832 The BSE Online Trading (BOLT)
BSE on line Trading (BOLT) facilities on-line screen based trading in securities
BOLT is currently operating in 25000 trader work stations located across over 399
cities in India
2833 BSEWEBXcom
In February 2001 BSE introduced the worldlsquos first centralized exchange based
Internet trading system BSEWEBXcom This initiative enables investors anywhere
in the world to trade on BSE platform
2834 Surveillance
BSElsquos Online Surveillance System (BOSS) monitors on a real time basis the price
movements volume position and real time measurements of the default risk market
reconstruct and generation of cross market alerts
2835 BSE Training Institute
BTI imparts capital market training and certification in collaboration with reputed
management institutes and universities It offers over 40 courses on various aspects of
the capital mark and financial sector More than 20000 people have attended the BTI
program
284 Awards
Fowling awards were given to BSE
The world council of Corporate Governance has awarded the Golden Peacock
Global CSR Award for BSElsquos initiatives in corporate social responsibility
The Annual Reports and Accounts of BSE for the year ended March 312006 and
42
March 312007 have been awarded the ICAI awards for excellence in financial
reporting
The Human Resource Management at BSE has won the Asia-Pacific HRM awards
for its efforts in employer branding through talent management at work health
management at work and excellence in HR through technology
Drawing from its rich past and its equally robust performance in the recent times
BSE will continue to remain an icon in the Indian Capital Market
285 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 days closing price is taken for computation of Index closure
The use of Index Closure Algorithm prevents any intentional manipulation of the
closing index value
286 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 affect the
index values The BSE Index Cell does the day-to-day maintenance of the index
within the broad index policy framework set by the BSE Index Committee The BSE
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 BSE Index Committee comprises
of capital market expert fund managers market participants and members of the BSE
Governing Board
43
287 On-Line Computation of the Index
During trading hours value of the Index is calculated and disseminated on real time
basis This is done automatically on the basis of prices at which trades in Index
constituents are executed
288 Adjustment for Bonus Rights and Newly Issued Capital
SENSEX calculation needs to be adjusted for issue of Bonus or 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 BSE Index Cell the base value is adjusted which is used to alter
market capitalization of the component stocks to arrive at the SENSEX value The
BSE Index Cell keeps a close watch on the events that might affect the index on a
regular basis and carries out daily maintenance of all the 19 Indices
2881 Adjustments for Rights Issues
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 (ex-right) price An offsetting or
proportionate adjustment is then made to the Base Market capitalization
2882 Adjustments for Bonus Issue
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
2883 Other Issues 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
buy-back of shares corporate restructuring etc
44
289 Listing Categories
Before badla was resumed in 1996 there were only two categories of securities listed
on the BSE the specified group of shares comprising The securities in which carry
forward deals were allowed and the cash group shares in which no carry forward deals
were permitted Later it was observed that the facility of carry forward was not being
used in all the 94 scrips in the specified group Hence after badla was resumed the
size of the specified group was reduced to 32 scrips on 3 April 1996 The BSE later
decided to regroup the existing A and B group shares into three categories The BSE
delisted 637 companies for a period of 3 years during 2004-05 for non-compliance of
listing agreements
A Group This group consists of large stock with turnover and high floating stock
with large market capitalization In other words scrips with more liquidity and high
networth are included in this group At present there are 150 scrips in this group
B1 Group This group includes scrips of quality companies with equity above Rs 3
crore with high growth potential and trading frequency No carry forward facility was
allowed in this group in June 2000 there were 1803 scrips in this group
B2 Group Scrips in this group were just like those of B1 but with fortnightly
settlement However in September 1996 the BSE introduced weekly settlement for all
scrips listed on the exchange thus doing away with the distinction between the B1 and
B2 groups On June 2000 there were 3219 scrips in this group
Z Group Subsequently a Z group was introduced in 1999 with scrips of companies
that do not meet the rules regulations and stipulations laid down by the exchange It
is a buyer beware company These are some 300 scrips in the group All Z category
stocks result in delivers
F Group A new Flsquo group pertaining to debt market segment was started with effect
from 9 September 1996
S Group The BSE reduced post-public issue capital base requirement from Rs10
crore to Rs3 crore to attract listing by companies with a smaller capital base It also
45
started a new trading segment small cap stock segment known as the Slsquo segment
Corporate with minimum turnover of an equal amount would be eligible to list scrips
on this segment In addition stocks listed on the regional exchanges would also be
able to list on the lsquoSlsquo segment subject to meeting certain criteria
2810 Base Market capitalization Adjustment
The formula for adjusting the Base Market capitalization is as follows
New Base Market Capitalization (NBMC)
New Market capitalization
NBMC = Old Base Market capitalization x mdashmdashmdashmdashmdashmdashmdashmdashmdashmdashmdash
Old Market capitalization
To illustrate suppose a company issues right shares which increases the market
capitalization of the shares of that company by say Rs100 crores The existing Base
Market capitalization (Old Base Market capitalization) say is Rs2450 crores and the
aggregate market capitalization of all the shares included in the index before the right
issue is made is say Rs4781 crore The New Base Market capitalization will then
be
2450x (4781+100)
_____________________ = Rs250124 crores
4781
This figure of Rs 250124 crore will be used as the Base Market capitalization for
calculating the index number from then onwards till the next base change becomes
necessary
Index Review Frequency
The BSE 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
29 STOCK MARKET INDEX
The stock market index is the most important indices of all as it measures overall
market sentiment through a set of stocks that representative of the market The stock
46
market index is a barometer of the market behavior It reflects direction and indicates
day-to-day fluctuations in stock prices The market index reflects expectations about
the behavior of the economy as a whole It is a precursor of economic cycles The
function of a stock index is to provide investors with information regarding the
average share price in the market An ideal index must represent changes in the prices
of the scrips and reflect price movements of typical shares for better market
representation Stock index is a barometer of a nationlsquos economic health as market
prices reflect expectations about the economylsquos performance Stock indices termed as
leading economic as they indicate what is going to happen in the economy in the
future The returns generated in the stock market are based on future expectations A
good market index incorporates a set of scrips which have high market capitalization
and high liquidity Market capitalization is the sum of the market value of all the
stocks included in the index The market value is derived by multiplying the price of
the share outstanding In other words the bid-ask spread is minimum The index on a
day is calculated as the percentage of the aggregate market value of the set of scrips
incorporated in the index on that day to the average market value of the same scrips
during the base period
291 Definition of an Index
A price index is such as the stock market price of the individual securities in the
market It reflects the overall price or return movements of a group of securities
Movements in an index are determined by sample weighting and computational
procedure Sample is normally generated by random selection or try a non random
selection technique designed to incorporate desired characteristics are used to select
sample shares rather than by completely random selection Major criteria for selection
are market activity due representation to various industrial groups and to major stock
exchanges
292 Global Stock Market Indices
2921 The Dow Jones Industrial averagersquos
It is the most widely watched and quoted index because of its long existence The
Dow has 30 constituents and it follows the methodology of price based weighted
47
Changes to stocks included in the Dow are infrequent three stocks were
addeddropped in 1991 four in 1997 and four in 1999 The addition of Microsoft and
Intel in 1999 was the first inclusion of Nasdaq market stocks to the Dow 30
2922 The Nasdaq composite index
The index is the market capitalization weighted of prices for all the stocks listed in the
Nasdaq stock market The Nasdaq composite began on 8 February 1971 with a base
of 100
2923 The Nasdaq 100 index
Nasdaq 100 comprises the largest computer software and telecom stocks by market
capitalization on the Nasdaq For a company to be included in the Nasdaq 100 it must
have a minimum average trading volume of 100000 shares per day and must have
been trading on a major exchange for at least a year or two
2924 The S amp P 500 index
This index comprises 500 biggest publicly traded companies in the US by market
capitalization Most money managers treat the S amp P 500 as a proxy for the US stock
market The S amp P 500 tries to cover all major areas of US economy To be included a
company must be profitable the prospective company must not be closely hold and
must have a large trading volume for its shares
2925 The FTSE 100
The FTSE 100 consists of the largest 100 companies by full market Value listed on
the London Stock Exchange The FTSE 100 is the benchmark index to indicate the
performance of the European market It is a market capitalization weighted index that
also considers the free float weighted of individual stocks before including them in
the index
2926 The MSCI Indices
Include the MSCIEAFE (Europe Australia and Far East) MSCI Europe MSCI
world MSCI (EMF) and MSCI Pacific Basin Indices
48
The MSCI world Index is a free float adjusted market capitalization index that is
designed to measure global developed market equity performance As of April 2002
the MSCI world Index consisted of the MSCI world Index consisted of the following
23 developed market country indices
Australia Austria Belgium Canada Denmark Finland France Germany Greece
Hong Kong Ireland Italy Japan Netherlands New Zealand Norway Singapore
Portugal Spain Sweden Switzerland United Kingdom and the United States of
America
293 Methodology for Calculating The Index
2931 Price Weighted Index
In this method the price of each stock in the index is summed up which is then
equated to an index starting value An arbitrary date is set as the base and the
Laspeyerlsquos Price Index which measures price changes against a fixed base period
quantity weight is used In case of a stock split the market price of the stock falls and
these results in less weighted in the index The Dow Jones Industrial Average and
Nikkie 225 are price-weighted indices
2932 Equal Weighting
In this method each stocklsquos percentage weight in the index is equal and hence all
stocks have an equal influence on the index movement The value line index at
Kansas City Board of Trade (KCBT) is an equal weighted index
2933 Market Capitalization Weighted
29331 Full Market Capitalization Method
In this method the number of shares outstanding multiplied by the market price of a
companylsquos share determines the scriplsquos weighted in the index The shares with the
highest market capitalization would have a higher weighted and would be most
influential in this type of index Eg S amp P 500 Index in USA and S amp P CNX Nify in
India
49
29332 Modified Capitalization Weighted
This method seeks to limit the influence of the largest stocks in the index which
otherwise would dominate the entire index This method sets a limit on the largest
stock or a group of stocks The NASDAQ 100 Index is calculated by using this
method
294 Free Float Market Capitalization Method
2941 Concept
Free float methodology refers to an index construction methodology that takes in to
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 Strategic holding government 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
All BSE indices with exception of BSE-PSU index have adopted the free-float
methodology
2942 Definition of Free Float
Share holding of investor that would not in the normal course come into the
open market for trading are treated as ―Controlling Strategic Holding and
hence not included in free float specifically the following categories of
holding are generally excluded from the definition of free float
Shares hold by foundersdirectorsacquires which has control element
Shares held by person with ―Controlling Interestlsquo
Shares held by Govt as promoters
50
Holding through the FDI Route
Strategic Stakes by private corporate bodiesindividuals
Equity held by employee welfare trusts
Locked-in-shares and shares which not be sold in the open market in normal
course
2943 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-agrave-Vis an investible
index This enables an apple-to-apple comparison thereby facilitating better
evaluation of performance of active managers
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 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
The free float methodology of index construction is considered to be an industry best
practice and all major index providers like MSCI FTSE SampP 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
51
29441 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 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 055 means that only 55 of the market
capitalization of the company will be considered for index calculation
Table 24 Free-float Bands
Free-Float Free-Float Factor Free-Float Free-Float Factor
gt0 - 5 005 gt50 - 55 055
gt5 - 10 010 gt55 - 60 060
gt10 - 15 015 gt60 - 65 065
gt15 - 20 020 gt65 - 70 070
gt20 - 25 025 gt70 - 75 075
gt25 - 30 030 gt75 - 80 080
gt30 - 35 035 gt80 - 85 085
gt35 - 40 040 gt85 - 90 090
gt40 - 45 045 gt90 - 95 095
gt45 - 50 050 gt95 - 100 100
Source wwwbseindiacom
295 BSE Indices
For the premier stock exchange that pioneered the securities transaction business
in India over a century of experience is a proud achievement A lot has changed since
1875 when 318 persons by paying a then princely amount of Re 1 became members
of what today is called Bombay Stock Exchange Limited (BSE) Over the decades
the stock market in the country has passed through good and bad periods The journey
52
in the 20th century has not been an easy one Till the decade of eighties there was no
measure or scale that could precisely measure the various ups and downs in the Indian
stock market BSE in 1986 came out with a Stock Index-SENSEX- that subsequently
became the barometer of the Indian stock market
The launch of SENSEX in 1986 was later followed up in January 1989 by
introduction of BSE National Index (Base 1983-84 = 100) It comprised 100 stocks
listed at five major stock exchanges in India - Mumbai Calcutta Delhi Ahmadabad
and Madras The BSE National Index was renamed BSE-100 Index from October 14
1996 and since then it is being calculated taking into consideration only the prices of
stocks listed at BSE BSE launched the dollar-linked version of BSE-100 index on
May 22 2006
With a view to provide a better representation of the increasing number of listed
companies larger market capitalization and the new industry sectors BSE launched
on 27th May 1994 two new index series viz the BSE-200 and the DOLLEX-200
Since then BSE has come a long way in attuning itself to the varied needs of
investors and market participants In order to fulfill the need for still broader
segment-specific and sector-specific indices BSE has continuously been increasing
the range of its indices BSE-500 Index and 5 sectorial indices were launched in 1999
In 2001 BSE launched BSE-PSU Index DOLLEX-30 and the countrys first free-
float based index - the BSE TEC Index Over the years BSE shifted all its indices to
the free-float methodology
BSE disseminates information on the Price-Earnings Ratio the Price to Book Value
Ratio and the Dividend Yield Percentage on day-to-day basis of all its major indices
The values of all BSE indices are updated on real time basis during market hours and
displayed through the BOLT system BSE website and news wire agencies
All BSE Indices are reviewed periodically by the BSE Index Committee This
Committee which comprises eminent independent finance professionals frames the
broad policy guidelines for the development and maintenance of all BSE indices The
BSE Index Cell carries out the day-to-day maintenance of all indices and conducts
research on development of new indices
53
2951 BSE-100 Index
A broad-based index the BSE-100 was formerly known as the BSE National index
This Index has 1983-84 as the base year and was launched in 1989 In line with the
shift of the BSE Indices to the globally accepted Free-Float methodology BSE-100
was shifted to Free-Float methodology effective from April 5 2004 The method of
computation of Free-Float index and determination of free-float factors is similar to
the methodology for SENSEX
Table 25 Index Specification
Base Year 1983-84
Base Index Value 100
Date of Launch 3-Jan-89
Method of calculation Launched on full market capitalization
method and effective April 05 2004
calculation method shifted to free-float
market capitalization
Number of scrips 100
Index calculation frequency Real Time
Source wwwbseindiacom
2952 Base Year
The financial year 1983-84 has been chosen as the base year The price stability
during that year and proximity to the index series were the main consideration for
choice of 1983-84 as the base year The base value was fixed at 100 points
2953 Dollex-100
BSE also calculates a dollar-linked version of SENSEX and historical values of this
index are available since its inception
2954 BSE-100 index - Scrip Selection Criteria
The general guidelines for selection of constituents in BSE-100 are as follows
Trading Frequency The scrip should have been traded on 95 of the trading days
54
in the last three months Exceptions can be made for extreme reasons like scrip
suspension etc
Final Rank The scrip should figure in the top 200 companies listed by final rank
The final rank is arrived at by assigning 75 weighted to the rank on the basis of
three-month average full market capitalization and 25 weighted to the liquidity rank
based on three-month average daily turnover amp three-month average impact cost
IndustrySector Representation Scrip selection would generally take into account a
balanced sectorial representation of the listed companies in the universe of BSE
Track Record In the opinion of the BSE Index Committee the company should
have an acceptable track record
210 STOCK MARKET VOLATILITY
2101 Meaning
Volatility is a measure for variation of price of a financial instrument over time
Historic volatility is derived from time series of past market prices An implied
volatility is derived from the market price of a market traded derivative (in particular
an option) Volatility does not measure the direction of price changes merely their
dispersion This is because when calculating standard deviation (or variance) all
differences are squared so that negative and positive differences are combined into
one quantity Two instruments with different volatilities may have the same expected
return but the instrument with higher volatility will have larger swings in values over
a given period of time
For example a lower volatility stock may have an expected (average) return of 7
with annual volatility of 5 This would indicate returns from approximately negative
3 to positive 17 most of the time (19 times out of 20 or 95 via a two standard
deviation rule) A higher volatility stock with the same expected return of 7 but
with annual volatility of 20 would indicate returns from approximately negative
33 to positive 47 most of the time (19 times out of 20 or 95) These estimates
assume a normal distribution in reality stocks are found to be leptokurtotic
55
2102 Terminology used in volatility
Volatility as described here refers to the actual current volatility of a financial
instrument for a specified period (for example 30 days or 90 days) It is the volatility
of a financial instrument based on historical prices over the specified period with the
last observation the most recent price This phrase is used particularly when it is
wished to distinguish between the actual current volatility of an instrument and
actual historical volatility which refers to the volatility of a financial instrument
over a specified period but with the last observation on a date in the past
actual future volatility which refers to the volatility of a financial instrument
over a specified period starting at the current time and ending at a future date
(normally the expiry date of an options)
historical implied volatility which refers to the implied volatility observed from
historical prices of the financial instrument (normally options)
current implied volatility which refers to the implied volatility observed from
current prices of the financial instrument
future implied volatility which refers to the implied volatility observed from
future prices of the financial instrument
For a financial instrument whose price follows a random walk or wiener process the
width of the distribution increases as time increases This is because there is an
increasing profitability that the instruments price will be farther away from the initial
price as time increases However rather than increase linearly the volatility increases
with the square-root of time as time increases because some fluctuations are expected
to cancel each other out so the most likely deviation after twice the time will not be
twice the distance from zero
2103 Usefulness of volatility for Investors
Investors care about volatility for five reasons
1 The wider the swings in an investments price the harder emotionally it is to
not worry
2 Price volatility of a trading instrument can define position sizing in a portfolio
56
3 When certain cash flows from selling a security are needed at a specific future
date higher volatility means a greater chance of a shortfall
4 Higher volatility of returns while saving for retirement results in a wider
distribution of possible final portfolio values
5 Higher volatility of return when retired gives withdrawals a larger permanent
impact on the portfolios value
6 Price volatility presents opportunities to buy assets cheaply and sell when
overpriced
28
Chart 23 Market Value
Chart 24 Total Share Turnovers
Source From the table 21
000 400000000 800000000 1200000000
Satildeo Paulo Stock Exchange
Toronto Stock ExchangeNew York Stock Exchange
Australian Securities ExchangeBombay Stock Exchange
Hong Kong Stock ExchangeKorea Exchange
National Stock Exchange of India
Shanghai Stock ExchangeShenzhen Stock Exchange
Tokyo Stock ExchangeEuro next
Frankfurt Stock Exchange (Deutsche Boumlrse)
London Stock ExchangeMadrid Stock Exchange (Bolsas y hellip
Milan Stock Exchange (Borsa Italiana)Nordic Stock Exchange Group OMX1
Swiss Exchange Market hellip
000 500000000 1000000000 1500000000
Satildeo Paulo Stock ExchangeToronto Stock Exchange
New York Stock ExchangeAustralian Securities Exchange
Bombay Stock ExchangeHong Kong Stock Exchange
Korea ExchangeNational Stock Exchange of India
Shanghai Stock ExchangeShenzhen Stock Exchange
Tokyo Stock ExchangeEuro next
Frankfurt Stock Exchange (Deutsche hellipLondon Stock Exchange
Madrid Stock Exchange (Bolsas y hellipMilan Stock Exchange (Borsa Italiana)Nordic Stock Exchange Group OMX1
Swiss Exchange Total Share hellip
29
25 REQUIREMENTS BY STOCK EXCHANGE
Companies have to meet the requirements of the exchange in order to have their
stocks and shares listed and traded there but requirements vary by stock exchanges
251 Bombay Stock Exchange
Bombay Stock Exchange (BSE) has requirements for a minimum market
capitalization of Rs250 Million and minimum public float equivalent to Rs100
Million31
252 London Stock Exchange
The main market of the London Stock Exchange has requirements for a minimum
market capitalization (pound700000) three years of audited financial statements
minimum public float (25 per cent) and sufficient working capital for at least 12
months from the date of listing
253 NASDAQ Stock Exchange
To be listed on the NASDAQ a company must have issued at least 125 million shares
of stock worth at least $70 million and must have earned more than $11 million over
the last three years 32
254 New York Stock Exchange
To be listed on the New York Stock Exchange (NYSE) a company must have issued
at least a million shares of stock worth $100 million and must have earned more than
$10 million over the last three years 33
255 Other types of exchanges
In the 19th century exchanges were opened to trade forward
contracts on commodities Exchange traded forward contracts are called futures
contracts These commodity exchanges later started offering future contracts on other
31 wwwbseindiacomaboutabintrobselistsecasp 32 NASDAQ Corporate -NASDAQ Listing Information wwnasdaqcomaboutlisting_informationstm 33 wwwnysecomFramesethtmldisplayPage=listed
30
products such as interest rates and shares as well as Options contracts They are now
generally known as futures exchanges
26 OWNERSHIP
Stock exchanges originated as mutual organizations owned by its member stock
brokers There has been a recent trend for stock exchanges to demutualize where the
members sell their shares in an initial public offering In this way the mutual
organization becomes a corporation with shares that are listed on a stock exchange
Examples are
Australian Securities Exchange (1998) Euro next (merged with New York Stock
Exchange) NASDAQ (2002) The New York Stock Exchange (2005) Bolsas
Mercados Espanoles and the Sao Paulo Stock Exchange (2007) The Shenzhen and
Shanghai stock exchanges can be characterized as quasi-state institutions insofar as
they were created by government bodies in China and their leading personnel are
directly appointed by the China Securities Regulatory Commission
27 HISTORY OF INDIAN STOCK MARKET
The stock exchange in Mumbai is more than 100 years old The origin of the stock
market in India dates back to the end of the eighteenth century when long term
negotiable securities were first issued The real beginning however occurred in the
middle of the nine teeth century after the enactment of the Companies Act in 1850
which introduced the feature of limited liability and generated investor interest in
corporate securities
The Native Share and Stock Brokerslsquo Association now known as the Bombay Stock
Exchange (BSE) was formed in Bombay (now Mumbai) in 1875 This was followed
by the formation of association in Ahmadabad in 1894 Calcutta (now Kolkata) in
1908 and Madras (now Chennai) in 1937 In order to promote the orderly
development of the stock market the central government introduced a comprehensive
legislation called the Securities Contracts (Regulation) Act 1956
31
The Calcutta Stock Exchange (CSE) was the largest stock exchange in India till the
1960s In 1961 there were 1203 listed companies across the various stock exchanges
of the country Of these 576 were listed on the CSE and 297 on the BSE However
during the later half of the 1960s the relative importance of the CSE declined while
that of the BSE increased sharply
One of the oldest stock markets in Asia the Indian Stock Markets have a 200 years
old history
Table 22 Origin of Indian Stock Market
Year Events
18th
Century
East India Company was the dominant institution and by end of the century business in its loan
securities gained full momentum
1830s Business on corporate stocks and shares in Bank and Cotton presses started in Bombay Trading list
by the end of 1839 got broader
1840s Recognition from banks and merchants to about half a dozen brokers
1850s Rapid development of commercial enterprise saw brokerage business attracting more people into
the business
1860s The number of brokers increased to 60
1860-61 The American Civil War broke out which caused a stoppage of cotton supply from United States of
America marking the beginning of the Share Mania in India
1862-63 The number of brokers increased to about 200 to 250
1865 A disastrous slump began at the end of the American Civil War (as an example Bank of Bombay
Share which had touched Rs 2850 could only be sold at Rs 87)
1874 With the rapidly developing share trading business brokers used to gather at a street (now well
known as Dalal Street) for the purpose of transacting business
1875 The Native Share and Stock Brokers Association (also known as The Bombay Stock
Exchange) was established in Bombay
1880s Development of cotton mills industry and set up of many others
1894 Establishment of The Ahmadabad Share and Stock Brokers Association
1880 -
90s
Sharp increase in share prices of jute industries in 1870s was followed by a boom in tea stocks and
coal
1908 The Calcutta Stock Exchange Association was formed
1920 Madras witnessed boom and business at The Madras Stock Exchange was transacted with 100
brokers
1923 When recession followed number of brokers came down to 3 and the Exchange was closed down
32
1934 Establishment of the Lahore Stock Exchange
1936 Merger of the Lahore Stock Exchange with the Punjab Stock Exchange
1937 Re-organization and set up of the Madras Stock Exchange Limited (Pvt) Limited led by
improvement in stock market activities in South India with establishment of new textile mills and
plantation companies
1940 Uttar Pradesh Stock Exchange Limited and Nagpur Stock Exchange Limited was established
1944 Establishment of The Hyderabad Stock Exchange Limited
1947 Delhi Stock and Share Brokers Association Limited and The Delhi Stocks and Shares Exchange
Limited were established and later on merged into The Delhi Stock Exchange Association
Limited
Sources wwwsurfindiacom wwwappuonlinecom
271 Post Independence Scenario
The depression witnessed after the Independence led to closure of a lot of exchanges
in the country Lahore Stock Exchange was closed down after the partition of India
and later on merged with the Delhi Stock Exchange Bangalore Stock Exchange
Limited was registered in 1957 and got recognition only by 1963 Most of the other
Exchanges were in a miserable state till 1957 when they applied for recognition under
Securities Contracts (Regulations) Act 1956 The Exchanges that were recognized
under the Act were
Bombay Calcutta Madras Ahmadabad Delhi Hyderabad Bangalore Indore
272 Many more stock exchanges were established during 1980s
namely
Cochin Stock Exchange (1980)
Uttar Pradesh Stock Exchange Association Limited (at Kanpur 1982)
Pune Stock Exchange Limited (1982)
Ludhiana Stock Exchange Association Limited (1983)
Gauhati Stock Exchange Limited (1984)
Kanara Stock Exchange Limited (at Mangalore 1985)
33
Magadh Stock Exchange Association (at Patna 1986)
Jaipur Stock Exchange Limited (1989)
Bhubaneswar Stock Exchange Association Limited (1989)
Saurashtra Kutch Stock Exchange Limited (at Rajkot 1989)
Vadodara Stock Exchange Limited (at Baroda 1990)
Coimbatore Stock Exchange
Meerut Stock Exchange
At present there are twenty one recognized stock exchanges in India which does not
include the Over The Counter Exchange of India Limited (OTCEI) and the National
Stock Exchange of India Limited (NSEIL)
Government policies during 1980s also played a vital role in the development of the
Indian Stock Markets There was a sharp increase in number of Exchanges listed
companies as well as their capital which is visible from the following table
Table 23 Pattern of Growth of Stock Exchanges
Source SEBI annual report
273 Trading Pattern of the Indian Stock Market
Indian Stock Exchanges allow trading of securities of only those public limited
companies that are listed on the Exchange(s) They are divided into two categories
S
No
As on 31st December 1946 1961 1971 1980 1991 1995 2000 2005
1 No of Stock Exchanges 7 7 8 9 20 22 23 23
2 No of Listed Cos 1125 1203 1599 2265 6229 8593 9413 4731
5 Market value of Capital
of Listed Cos (Cr Rs)
971 1292 2675 6750 110279 478121 6319212 478121
34
Chart 25 Trading Pattern of the Indian Stock Market
Source wwwbseindiacom
274 Types of Transactions
The flowchart below describes the types of transactions that can be carried out on the
Indian stock exchanges
Chart 26 Types of Transactions
Source wwwbseindiacom
Listed Securities of Public limited companies
Specified securities (forward List)
Equity shares of company that are
- Dividend paying
- growth orinted companies
- paid up capital of atleast Rs50 million
- Market capitalisation of atleast Rs100 million
- has more than 20000 shareholders
Non specicied Securities (Cash List)
equity shares of companies not covered in specified securities
Transactions on Indian Stock Exchanges
Spot Delivery Transactions
Forward Transactions
35
Spot Delivery Transactions
Includes transactions that require delivery and payment within stipulated time
period at the time of entering into the contract
This period shall not be more than 14 days following the date of the contract
Forward Transactions
Transactions in which delivery and payment can be extended by further period
of 14 days each
The overall period should not exceed 90 days from the date of contract
Transactions permitted only in case of specified shares
275 Indian stock exchange allows a member broker to perform
following activities
Act as an agent
Buy and sell securities for clients and charge commission for the same
Act as a trader or dealer as a principal
Buy and sell securities on their account and risk
276 Over The Counter Exchange of India (OTCEI)
Traditionally trading in Stock Exchanges in India followed a conventional style
where people used to gather at the Exchange and bids and offers were made by open
outcry This age-old trading mechanism in the Indian stock markets used to create
much functional inefficiency Lack of liquidity and transparency long settlement
periods and benami transactions are a few examples that adversely affected investors
In order to overcome these inefficiencies OTCEI was incorporated in 1990 under the
Companies Act 1956 OTCEI is the first screen based nationwide stock exchange in
India created by Unit Trust of India Industrial Credit and Investment Corporation of
India Industrial Development Bank of India SBI Capital Markets Industrial Finance
Corporation of India General Insurance Corporation and its subsidiaries and Can
Bank Financial Services
36
Chart 27 Securities traded on the OTCEI
Source wwwbseindiacom
Listed Securities
Securities of the companies listed on the OTC
Can be bought or sold at any OTC counter across India
Should not be listed anywhere else
Permitted Securities
Certain securities (Shares and debentures listed on other exchanges)
Unites of Mutual funds can be traded
Initiated Debentures
An equity holding a minimum of one lakh debentures of a particular scrip can
offer them for trading on the OTC
Advantages of OTCEI
Greater liquidity and lesser risk of intermediary charges due to widely spread trading
mechanism across India The screen-based scrip less trading ensures transparency and
accuracy of prices Faster settlement and transfer process as compared to other
exchanges Shorter allotment procedure (in case of a new issue) than other exchanges
277 National Stock Exchange
In order to lift the Indian stock market trading system at par with the international
standards On the basis of the recommendations of high powered Pherwani
Securities teaded on the
OTCEI
Listed Securities
Permitted Securities
Initiated Debentures
37
Committee the National Stock Exchange was incorporated in 1992 by Industrial
Development Bank of India Industrial Credit and Investment Corporation of India
Industrial Finance Corporation of India all Insurance Corporations selected
commercial banks and others
2771 NSE provides exposure to investors in two types of markets
namely
Wholesale debt market
Capital market
Wholesale Debt Market - Similar to money market operations debt market
operations involve institutional investors and corporate bodies entering into
transactions of high value in financial instruments like treasury bills government
securities commercial papers etc
Capital market- A capital market is a market for securities (debt or equity) where
business enterprises and governments can raise long term funds It is defined as a
market in which money is defined as a market in which money is provided for periods
longer than a year34 as the raising of short term funds takes place on other markets
Capital markets may be classified as primary markets and secondary markets In
primary markets new stock or bond issues are sold to investors via a mechanism
known as underwriting In the secondary markets existing securities are sold and
bought among investors or traders usually on a securities exchange over the counter
or elsewhere
278 Trading at NSE amp BSE
Fully automated screen-based trading mechanism
Strictly follows the principle of an order-driven market
Trading members are linked through a communication network
34 Steven M Sheffrin (2003) Economics Principles in action Upper Saddle River Pearson Prentice
Hall
38
This network allows them to execute trade from their offices
The prices at which the buyer and seller are willing to transact will appear on
the screen
When the prices match the transaction will be completed
A confirmation slip will be printed at the office of the trading member
2781 Advantages of trading at NSE amp BSE
Integrated network for trading in stock market of India
Fully automated screen based system that provides higher degree of
transparency
Investors can transact from any part of the country at uniform prices
Greater functional efficiency supported by totally computerized network
28 THE BOMBAY STOCK EXCHANGE
Formerly the Stock Exchange Mumbai popularly called Bombay Stock Exchange
or BSE is the oldest stock exchange in Asia and has the greatest number of listed
companies in the world with 4700 listed as of August 2007 35
It is located at Dalal Street Mumbai India On 31 December 2007 the equity market
capitalization of the BSE was US $ 179 trillion making it the largest stock exchange
in South Asia and the 12th largest in the world
With over 4700 Indian companies list on the stock exchange [10]
and it has a
significant trading volume The BSE SENSEX (SENSITIVE INDEX) also called the
―BSE 30 is a widely used market index in India and Asia Though many other
exchanges exist BSE and the National Stock Exchange of India account for most of
the trading in shares in India
35 World Federation of Exchanges (2007) wwwworld-exchangesorg
39
281 History of the Bombay Stock exchange
Trading in securities has been in vogue in India for a little over 200 years Trading in
securities dates back 1793 most of them being transactions in loan securities of the
East India Company The broking community prospered as there was a rise in prices
which led to a share mania during 1861-65 This bubble burst in 1865 when the
American Civil War ended The brokers realized that investor confidence in the
securities market could be sustained only by organizing themselves into a regulated
body with defined rules and regulations The realization resulted in formation of ―The
Native Share and Stock Brokerslsquo Association which later came to be known as the
Bombay Stock Exchange In 1875 these brokers assembled at a place now called
Dalal Street
The Bombay Stock Exchange is a voluntary nonprofit making association of broker
members It emerged as a premier stock exchange after the 1960 The increased pace
of industrialization caused by the two world wars protection to the domestic industry
and the governmentlsquos fiscal policies aided the growth of new issues which in turn
helped the BSE to prosper The BSE dominated the Indian Capital Market by
accounting for more than 60 per cent of the all Indian turn over
Until 1992 the BSE operated like a closed club of selected members With the
securities scam outburst in 1992 and the SEBI taking over the rains of the Stock
Market the BSE had to bring about changes in its operational policies Until March
1995 the BSE had an open outcry system of trading However when faced with stiff
competition from NSE the countrylsquos first modern computerized and professionally
managed stock exchange set up in 1994 the BSE had to change its system of trading
and operation
On 14 March 1995 the BSE turned to electronic trading whereby brokers trade using
computers This system is known as the BSE On-line Trading System (BOLT)
The introduction of BOLT helped in improving trading volumes significantly
reducing the spread between buy and sell orders better trading in odd lot shares fixed
income instruments and dealings in the renunciation of rights shares
40
In 1995 BOLT was limited to Mumbai whereas the NSE was operating at the
national level As a result the BSE submitted a proposal for allowing installation of
terminals connected to BOLT in centers outside Mumbai After rejecting the proposal
four times on 29 october 1996 the SEBI finally allowed the BSE to use its BOLT
system nationwide Later the BSE set up a central depository system to dematerialize
shares and promote demate Account (trading)
282 Hours of Operation
Beginning of the Day Session 800 to 900
Trading Session 900 to 1530
Position Transfer Session 1530 to 1550
Closing Session 1550 to 1605
Option Exercise Session 1605 to 1635
Margin Session 1635 to 1650
Query Session 1650 to1735
End of Day Session 1735
The hours of operation for the BSE quoted above are stated in terms of the local time
(ie GMT+530) in Mumbai India
BSElsquos normal trading sessions are on all days of the week except Saturdays Sundays
and Holidays declared by the Exchange in advance 36
283 Services of BSE
BSE also had a wide range of services to empower investors and facilitate smooth
transactions These services are as follows
2831 Investor Services
The Dept of investor services redresses grievances of investors BSE was the first
exchange in the country to provide an amount of Rs 1 million towards the investor
36 Asia Technical Analysis with Phil Smith wwwreutersindianet
41
protection fund it is an amount higher than that of any exchange in the country BSE
launched a nationwide investor awareness program ―Safe Investing in the Stock
Market under which 264 programmers were held in more than 200 cities
2832 The BSE Online Trading (BOLT)
BSE on line Trading (BOLT) facilities on-line screen based trading in securities
BOLT is currently operating in 25000 trader work stations located across over 399
cities in India
2833 BSEWEBXcom
In February 2001 BSE introduced the worldlsquos first centralized exchange based
Internet trading system BSEWEBXcom This initiative enables investors anywhere
in the world to trade on BSE platform
2834 Surveillance
BSElsquos Online Surveillance System (BOSS) monitors on a real time basis the price
movements volume position and real time measurements of the default risk market
reconstruct and generation of cross market alerts
2835 BSE Training Institute
BTI imparts capital market training and certification in collaboration with reputed
management institutes and universities It offers over 40 courses on various aspects of
the capital mark and financial sector More than 20000 people have attended the BTI
program
284 Awards
Fowling awards were given to BSE
The world council of Corporate Governance has awarded the Golden Peacock
Global CSR Award for BSElsquos initiatives in corporate social responsibility
The Annual Reports and Accounts of BSE for the year ended March 312006 and
42
March 312007 have been awarded the ICAI awards for excellence in financial
reporting
The Human Resource Management at BSE has won the Asia-Pacific HRM awards
for its efforts in employer branding through talent management at work health
management at work and excellence in HR through technology
Drawing from its rich past and its equally robust performance in the recent times
BSE will continue to remain an icon in the Indian Capital Market
285 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 days closing price is taken for computation of Index closure
The use of Index Closure Algorithm prevents any intentional manipulation of the
closing index value
286 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 affect the
index values The BSE Index Cell does the day-to-day maintenance of the index
within the broad index policy framework set by the BSE Index Committee The BSE
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 BSE Index Committee comprises
of capital market expert fund managers market participants and members of the BSE
Governing Board
43
287 On-Line Computation of the Index
During trading hours value of the Index is calculated and disseminated on real time
basis This is done automatically on the basis of prices at which trades in Index
constituents are executed
288 Adjustment for Bonus Rights and Newly Issued Capital
SENSEX calculation needs to be adjusted for issue of Bonus or 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 BSE Index Cell the base value is adjusted which is used to alter
market capitalization of the component stocks to arrive at the SENSEX value The
BSE Index Cell keeps a close watch on the events that might affect the index on a
regular basis and carries out daily maintenance of all the 19 Indices
2881 Adjustments for Rights Issues
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 (ex-right) price An offsetting or
proportionate adjustment is then made to the Base Market capitalization
2882 Adjustments for Bonus Issue
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
2883 Other Issues 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
buy-back of shares corporate restructuring etc
44
289 Listing Categories
Before badla was resumed in 1996 there were only two categories of securities listed
on the BSE the specified group of shares comprising The securities in which carry
forward deals were allowed and the cash group shares in which no carry forward deals
were permitted Later it was observed that the facility of carry forward was not being
used in all the 94 scrips in the specified group Hence after badla was resumed the
size of the specified group was reduced to 32 scrips on 3 April 1996 The BSE later
decided to regroup the existing A and B group shares into three categories The BSE
delisted 637 companies for a period of 3 years during 2004-05 for non-compliance of
listing agreements
A Group This group consists of large stock with turnover and high floating stock
with large market capitalization In other words scrips with more liquidity and high
networth are included in this group At present there are 150 scrips in this group
B1 Group This group includes scrips of quality companies with equity above Rs 3
crore with high growth potential and trading frequency No carry forward facility was
allowed in this group in June 2000 there were 1803 scrips in this group
B2 Group Scrips in this group were just like those of B1 but with fortnightly
settlement However in September 1996 the BSE introduced weekly settlement for all
scrips listed on the exchange thus doing away with the distinction between the B1 and
B2 groups On June 2000 there were 3219 scrips in this group
Z Group Subsequently a Z group was introduced in 1999 with scrips of companies
that do not meet the rules regulations and stipulations laid down by the exchange It
is a buyer beware company These are some 300 scrips in the group All Z category
stocks result in delivers
F Group A new Flsquo group pertaining to debt market segment was started with effect
from 9 September 1996
S Group The BSE reduced post-public issue capital base requirement from Rs10
crore to Rs3 crore to attract listing by companies with a smaller capital base It also
45
started a new trading segment small cap stock segment known as the Slsquo segment
Corporate with minimum turnover of an equal amount would be eligible to list scrips
on this segment In addition stocks listed on the regional exchanges would also be
able to list on the lsquoSlsquo segment subject to meeting certain criteria
2810 Base Market capitalization Adjustment
The formula for adjusting the Base Market capitalization is as follows
New Base Market Capitalization (NBMC)
New Market capitalization
NBMC = Old Base Market capitalization x mdashmdashmdashmdashmdashmdashmdashmdashmdashmdashmdash
Old Market capitalization
To illustrate suppose a company issues right shares which increases the market
capitalization of the shares of that company by say Rs100 crores The existing Base
Market capitalization (Old Base Market capitalization) say is Rs2450 crores and the
aggregate market capitalization of all the shares included in the index before the right
issue is made is say Rs4781 crore The New Base Market capitalization will then
be
2450x (4781+100)
_____________________ = Rs250124 crores
4781
This figure of Rs 250124 crore will be used as the Base Market capitalization for
calculating the index number from then onwards till the next base change becomes
necessary
Index Review Frequency
The BSE 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
29 STOCK MARKET INDEX
The stock market index is the most important indices of all as it measures overall
market sentiment through a set of stocks that representative of the market The stock
46
market index is a barometer of the market behavior It reflects direction and indicates
day-to-day fluctuations in stock prices The market index reflects expectations about
the behavior of the economy as a whole It is a precursor of economic cycles The
function of a stock index is to provide investors with information regarding the
average share price in the market An ideal index must represent changes in the prices
of the scrips and reflect price movements of typical shares for better market
representation Stock index is a barometer of a nationlsquos economic health as market
prices reflect expectations about the economylsquos performance Stock indices termed as
leading economic as they indicate what is going to happen in the economy in the
future The returns generated in the stock market are based on future expectations A
good market index incorporates a set of scrips which have high market capitalization
and high liquidity Market capitalization is the sum of the market value of all the
stocks included in the index The market value is derived by multiplying the price of
the share outstanding In other words the bid-ask spread is minimum The index on a
day is calculated as the percentage of the aggregate market value of the set of scrips
incorporated in the index on that day to the average market value of the same scrips
during the base period
291 Definition of an Index
A price index is such as the stock market price of the individual securities in the
market It reflects the overall price or return movements of a group of securities
Movements in an index are determined by sample weighting and computational
procedure Sample is normally generated by random selection or try a non random
selection technique designed to incorporate desired characteristics are used to select
sample shares rather than by completely random selection Major criteria for selection
are market activity due representation to various industrial groups and to major stock
exchanges
292 Global Stock Market Indices
2921 The Dow Jones Industrial averagersquos
It is the most widely watched and quoted index because of its long existence The
Dow has 30 constituents and it follows the methodology of price based weighted
47
Changes to stocks included in the Dow are infrequent three stocks were
addeddropped in 1991 four in 1997 and four in 1999 The addition of Microsoft and
Intel in 1999 was the first inclusion of Nasdaq market stocks to the Dow 30
2922 The Nasdaq composite index
The index is the market capitalization weighted of prices for all the stocks listed in the
Nasdaq stock market The Nasdaq composite began on 8 February 1971 with a base
of 100
2923 The Nasdaq 100 index
Nasdaq 100 comprises the largest computer software and telecom stocks by market
capitalization on the Nasdaq For a company to be included in the Nasdaq 100 it must
have a minimum average trading volume of 100000 shares per day and must have
been trading on a major exchange for at least a year or two
2924 The S amp P 500 index
This index comprises 500 biggest publicly traded companies in the US by market
capitalization Most money managers treat the S amp P 500 as a proxy for the US stock
market The S amp P 500 tries to cover all major areas of US economy To be included a
company must be profitable the prospective company must not be closely hold and
must have a large trading volume for its shares
2925 The FTSE 100
The FTSE 100 consists of the largest 100 companies by full market Value listed on
the London Stock Exchange The FTSE 100 is the benchmark index to indicate the
performance of the European market It is a market capitalization weighted index that
also considers the free float weighted of individual stocks before including them in
the index
2926 The MSCI Indices
Include the MSCIEAFE (Europe Australia and Far East) MSCI Europe MSCI
world MSCI (EMF) and MSCI Pacific Basin Indices
48
The MSCI world Index is a free float adjusted market capitalization index that is
designed to measure global developed market equity performance As of April 2002
the MSCI world Index consisted of the MSCI world Index consisted of the following
23 developed market country indices
Australia Austria Belgium Canada Denmark Finland France Germany Greece
Hong Kong Ireland Italy Japan Netherlands New Zealand Norway Singapore
Portugal Spain Sweden Switzerland United Kingdom and the United States of
America
293 Methodology for Calculating The Index
2931 Price Weighted Index
In this method the price of each stock in the index is summed up which is then
equated to an index starting value An arbitrary date is set as the base and the
Laspeyerlsquos Price Index which measures price changes against a fixed base period
quantity weight is used In case of a stock split the market price of the stock falls and
these results in less weighted in the index The Dow Jones Industrial Average and
Nikkie 225 are price-weighted indices
2932 Equal Weighting
In this method each stocklsquos percentage weight in the index is equal and hence all
stocks have an equal influence on the index movement The value line index at
Kansas City Board of Trade (KCBT) is an equal weighted index
2933 Market Capitalization Weighted
29331 Full Market Capitalization Method
In this method the number of shares outstanding multiplied by the market price of a
companylsquos share determines the scriplsquos weighted in the index The shares with the
highest market capitalization would have a higher weighted and would be most
influential in this type of index Eg S amp P 500 Index in USA and S amp P CNX Nify in
India
49
29332 Modified Capitalization Weighted
This method seeks to limit the influence of the largest stocks in the index which
otherwise would dominate the entire index This method sets a limit on the largest
stock or a group of stocks The NASDAQ 100 Index is calculated by using this
method
294 Free Float Market Capitalization Method
2941 Concept
Free float methodology refers to an index construction methodology that takes in to
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 Strategic holding government 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
All BSE indices with exception of BSE-PSU index have adopted the free-float
methodology
2942 Definition of Free Float
Share holding of investor that would not in the normal course come into the
open market for trading are treated as ―Controlling Strategic Holding and
hence not included in free float specifically the following categories of
holding are generally excluded from the definition of free float
Shares hold by foundersdirectorsacquires which has control element
Shares held by person with ―Controlling Interestlsquo
Shares held by Govt as promoters
50
Holding through the FDI Route
Strategic Stakes by private corporate bodiesindividuals
Equity held by employee welfare trusts
Locked-in-shares and shares which not be sold in the open market in normal
course
2943 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-agrave-Vis an investible
index This enables an apple-to-apple comparison thereby facilitating better
evaluation of performance of active managers
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 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
The free float methodology of index construction is considered to be an industry best
practice and all major index providers like MSCI FTSE SampP 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
51
29441 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 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 055 means that only 55 of the market
capitalization of the company will be considered for index calculation
Table 24 Free-float Bands
Free-Float Free-Float Factor Free-Float Free-Float Factor
gt0 - 5 005 gt50 - 55 055
gt5 - 10 010 gt55 - 60 060
gt10 - 15 015 gt60 - 65 065
gt15 - 20 020 gt65 - 70 070
gt20 - 25 025 gt70 - 75 075
gt25 - 30 030 gt75 - 80 080
gt30 - 35 035 gt80 - 85 085
gt35 - 40 040 gt85 - 90 090
gt40 - 45 045 gt90 - 95 095
gt45 - 50 050 gt95 - 100 100
Source wwwbseindiacom
295 BSE Indices
For the premier stock exchange that pioneered the securities transaction business
in India over a century of experience is a proud achievement A lot has changed since
1875 when 318 persons by paying a then princely amount of Re 1 became members
of what today is called Bombay Stock Exchange Limited (BSE) Over the decades
the stock market in the country has passed through good and bad periods The journey
52
in the 20th century has not been an easy one Till the decade of eighties there was no
measure or scale that could precisely measure the various ups and downs in the Indian
stock market BSE in 1986 came out with a Stock Index-SENSEX- that subsequently
became the barometer of the Indian stock market
The launch of SENSEX in 1986 was later followed up in January 1989 by
introduction of BSE National Index (Base 1983-84 = 100) It comprised 100 stocks
listed at five major stock exchanges in India - Mumbai Calcutta Delhi Ahmadabad
and Madras The BSE National Index was renamed BSE-100 Index from October 14
1996 and since then it is being calculated taking into consideration only the prices of
stocks listed at BSE BSE launched the dollar-linked version of BSE-100 index on
May 22 2006
With a view to provide a better representation of the increasing number of listed
companies larger market capitalization and the new industry sectors BSE launched
on 27th May 1994 two new index series viz the BSE-200 and the DOLLEX-200
Since then BSE has come a long way in attuning itself to the varied needs of
investors and market participants In order to fulfill the need for still broader
segment-specific and sector-specific indices BSE has continuously been increasing
the range of its indices BSE-500 Index and 5 sectorial indices were launched in 1999
In 2001 BSE launched BSE-PSU Index DOLLEX-30 and the countrys first free-
float based index - the BSE TEC Index Over the years BSE shifted all its indices to
the free-float methodology
BSE disseminates information on the Price-Earnings Ratio the Price to Book Value
Ratio and the Dividend Yield Percentage on day-to-day basis of all its major indices
The values of all BSE indices are updated on real time basis during market hours and
displayed through the BOLT system BSE website and news wire agencies
All BSE Indices are reviewed periodically by the BSE Index Committee This
Committee which comprises eminent independent finance professionals frames the
broad policy guidelines for the development and maintenance of all BSE indices The
BSE Index Cell carries out the day-to-day maintenance of all indices and conducts
research on development of new indices
53
2951 BSE-100 Index
A broad-based index the BSE-100 was formerly known as the BSE National index
This Index has 1983-84 as the base year and was launched in 1989 In line with the
shift of the BSE Indices to the globally accepted Free-Float methodology BSE-100
was shifted to Free-Float methodology effective from April 5 2004 The method of
computation of Free-Float index and determination of free-float factors is similar to
the methodology for SENSEX
Table 25 Index Specification
Base Year 1983-84
Base Index Value 100
Date of Launch 3-Jan-89
Method of calculation Launched on full market capitalization
method and effective April 05 2004
calculation method shifted to free-float
market capitalization
Number of scrips 100
Index calculation frequency Real Time
Source wwwbseindiacom
2952 Base Year
The financial year 1983-84 has been chosen as the base year The price stability
during that year and proximity to the index series were the main consideration for
choice of 1983-84 as the base year The base value was fixed at 100 points
2953 Dollex-100
BSE also calculates a dollar-linked version of SENSEX and historical values of this
index are available since its inception
2954 BSE-100 index - Scrip Selection Criteria
The general guidelines for selection of constituents in BSE-100 are as follows
Trading Frequency The scrip should have been traded on 95 of the trading days
54
in the last three months Exceptions can be made for extreme reasons like scrip
suspension etc
Final Rank The scrip should figure in the top 200 companies listed by final rank
The final rank is arrived at by assigning 75 weighted to the rank on the basis of
three-month average full market capitalization and 25 weighted to the liquidity rank
based on three-month average daily turnover amp three-month average impact cost
IndustrySector Representation Scrip selection would generally take into account a
balanced sectorial representation of the listed companies in the universe of BSE
Track Record In the opinion of the BSE Index Committee the company should
have an acceptable track record
210 STOCK MARKET VOLATILITY
2101 Meaning
Volatility is a measure for variation of price of a financial instrument over time
Historic volatility is derived from time series of past market prices An implied
volatility is derived from the market price of a market traded derivative (in particular
an option) Volatility does not measure the direction of price changes merely their
dispersion This is because when calculating standard deviation (or variance) all
differences are squared so that negative and positive differences are combined into
one quantity Two instruments with different volatilities may have the same expected
return but the instrument with higher volatility will have larger swings in values over
a given period of time
For example a lower volatility stock may have an expected (average) return of 7
with annual volatility of 5 This would indicate returns from approximately negative
3 to positive 17 most of the time (19 times out of 20 or 95 via a two standard
deviation rule) A higher volatility stock with the same expected return of 7 but
with annual volatility of 20 would indicate returns from approximately negative
33 to positive 47 most of the time (19 times out of 20 or 95) These estimates
assume a normal distribution in reality stocks are found to be leptokurtotic
55
2102 Terminology used in volatility
Volatility as described here refers to the actual current volatility of a financial
instrument for a specified period (for example 30 days or 90 days) It is the volatility
of a financial instrument based on historical prices over the specified period with the
last observation the most recent price This phrase is used particularly when it is
wished to distinguish between the actual current volatility of an instrument and
actual historical volatility which refers to the volatility of a financial instrument
over a specified period but with the last observation on a date in the past
actual future volatility which refers to the volatility of a financial instrument
over a specified period starting at the current time and ending at a future date
(normally the expiry date of an options)
historical implied volatility which refers to the implied volatility observed from
historical prices of the financial instrument (normally options)
current implied volatility which refers to the implied volatility observed from
current prices of the financial instrument
future implied volatility which refers to the implied volatility observed from
future prices of the financial instrument
For a financial instrument whose price follows a random walk or wiener process the
width of the distribution increases as time increases This is because there is an
increasing profitability that the instruments price will be farther away from the initial
price as time increases However rather than increase linearly the volatility increases
with the square-root of time as time increases because some fluctuations are expected
to cancel each other out so the most likely deviation after twice the time will not be
twice the distance from zero
2103 Usefulness of volatility for Investors
Investors care about volatility for five reasons
1 The wider the swings in an investments price the harder emotionally it is to
not worry
2 Price volatility of a trading instrument can define position sizing in a portfolio
56
3 When certain cash flows from selling a security are needed at a specific future
date higher volatility means a greater chance of a shortfall
4 Higher volatility of returns while saving for retirement results in a wider
distribution of possible final portfolio values
5 Higher volatility of return when retired gives withdrawals a larger permanent
impact on the portfolios value
6 Price volatility presents opportunities to buy assets cheaply and sell when
overpriced
29
25 REQUIREMENTS BY STOCK EXCHANGE
Companies have to meet the requirements of the exchange in order to have their
stocks and shares listed and traded there but requirements vary by stock exchanges
251 Bombay Stock Exchange
Bombay Stock Exchange (BSE) has requirements for a minimum market
capitalization of Rs250 Million and minimum public float equivalent to Rs100
Million31
252 London Stock Exchange
The main market of the London Stock Exchange has requirements for a minimum
market capitalization (pound700000) three years of audited financial statements
minimum public float (25 per cent) and sufficient working capital for at least 12
months from the date of listing
253 NASDAQ Stock Exchange
To be listed on the NASDAQ a company must have issued at least 125 million shares
of stock worth at least $70 million and must have earned more than $11 million over
the last three years 32
254 New York Stock Exchange
To be listed on the New York Stock Exchange (NYSE) a company must have issued
at least a million shares of stock worth $100 million and must have earned more than
$10 million over the last three years 33
255 Other types of exchanges
In the 19th century exchanges were opened to trade forward
contracts on commodities Exchange traded forward contracts are called futures
contracts These commodity exchanges later started offering future contracts on other
31 wwwbseindiacomaboutabintrobselistsecasp 32 NASDAQ Corporate -NASDAQ Listing Information wwnasdaqcomaboutlisting_informationstm 33 wwwnysecomFramesethtmldisplayPage=listed
30
products such as interest rates and shares as well as Options contracts They are now
generally known as futures exchanges
26 OWNERSHIP
Stock exchanges originated as mutual organizations owned by its member stock
brokers There has been a recent trend for stock exchanges to demutualize where the
members sell their shares in an initial public offering In this way the mutual
organization becomes a corporation with shares that are listed on a stock exchange
Examples are
Australian Securities Exchange (1998) Euro next (merged with New York Stock
Exchange) NASDAQ (2002) The New York Stock Exchange (2005) Bolsas
Mercados Espanoles and the Sao Paulo Stock Exchange (2007) The Shenzhen and
Shanghai stock exchanges can be characterized as quasi-state institutions insofar as
they were created by government bodies in China and their leading personnel are
directly appointed by the China Securities Regulatory Commission
27 HISTORY OF INDIAN STOCK MARKET
The stock exchange in Mumbai is more than 100 years old The origin of the stock
market in India dates back to the end of the eighteenth century when long term
negotiable securities were first issued The real beginning however occurred in the
middle of the nine teeth century after the enactment of the Companies Act in 1850
which introduced the feature of limited liability and generated investor interest in
corporate securities
The Native Share and Stock Brokerslsquo Association now known as the Bombay Stock
Exchange (BSE) was formed in Bombay (now Mumbai) in 1875 This was followed
by the formation of association in Ahmadabad in 1894 Calcutta (now Kolkata) in
1908 and Madras (now Chennai) in 1937 In order to promote the orderly
development of the stock market the central government introduced a comprehensive
legislation called the Securities Contracts (Regulation) Act 1956
31
The Calcutta Stock Exchange (CSE) was the largest stock exchange in India till the
1960s In 1961 there were 1203 listed companies across the various stock exchanges
of the country Of these 576 were listed on the CSE and 297 on the BSE However
during the later half of the 1960s the relative importance of the CSE declined while
that of the BSE increased sharply
One of the oldest stock markets in Asia the Indian Stock Markets have a 200 years
old history
Table 22 Origin of Indian Stock Market
Year Events
18th
Century
East India Company was the dominant institution and by end of the century business in its loan
securities gained full momentum
1830s Business on corporate stocks and shares in Bank and Cotton presses started in Bombay Trading list
by the end of 1839 got broader
1840s Recognition from banks and merchants to about half a dozen brokers
1850s Rapid development of commercial enterprise saw brokerage business attracting more people into
the business
1860s The number of brokers increased to 60
1860-61 The American Civil War broke out which caused a stoppage of cotton supply from United States of
America marking the beginning of the Share Mania in India
1862-63 The number of brokers increased to about 200 to 250
1865 A disastrous slump began at the end of the American Civil War (as an example Bank of Bombay
Share which had touched Rs 2850 could only be sold at Rs 87)
1874 With the rapidly developing share trading business brokers used to gather at a street (now well
known as Dalal Street) for the purpose of transacting business
1875 The Native Share and Stock Brokers Association (also known as The Bombay Stock
Exchange) was established in Bombay
1880s Development of cotton mills industry and set up of many others
1894 Establishment of The Ahmadabad Share and Stock Brokers Association
1880 -
90s
Sharp increase in share prices of jute industries in 1870s was followed by a boom in tea stocks and
coal
1908 The Calcutta Stock Exchange Association was formed
1920 Madras witnessed boom and business at The Madras Stock Exchange was transacted with 100
brokers
1923 When recession followed number of brokers came down to 3 and the Exchange was closed down
32
1934 Establishment of the Lahore Stock Exchange
1936 Merger of the Lahore Stock Exchange with the Punjab Stock Exchange
1937 Re-organization and set up of the Madras Stock Exchange Limited (Pvt) Limited led by
improvement in stock market activities in South India with establishment of new textile mills and
plantation companies
1940 Uttar Pradesh Stock Exchange Limited and Nagpur Stock Exchange Limited was established
1944 Establishment of The Hyderabad Stock Exchange Limited
1947 Delhi Stock and Share Brokers Association Limited and The Delhi Stocks and Shares Exchange
Limited were established and later on merged into The Delhi Stock Exchange Association
Limited
Sources wwwsurfindiacom wwwappuonlinecom
271 Post Independence Scenario
The depression witnessed after the Independence led to closure of a lot of exchanges
in the country Lahore Stock Exchange was closed down after the partition of India
and later on merged with the Delhi Stock Exchange Bangalore Stock Exchange
Limited was registered in 1957 and got recognition only by 1963 Most of the other
Exchanges were in a miserable state till 1957 when they applied for recognition under
Securities Contracts (Regulations) Act 1956 The Exchanges that were recognized
under the Act were
Bombay Calcutta Madras Ahmadabad Delhi Hyderabad Bangalore Indore
272 Many more stock exchanges were established during 1980s
namely
Cochin Stock Exchange (1980)
Uttar Pradesh Stock Exchange Association Limited (at Kanpur 1982)
Pune Stock Exchange Limited (1982)
Ludhiana Stock Exchange Association Limited (1983)
Gauhati Stock Exchange Limited (1984)
Kanara Stock Exchange Limited (at Mangalore 1985)
33
Magadh Stock Exchange Association (at Patna 1986)
Jaipur Stock Exchange Limited (1989)
Bhubaneswar Stock Exchange Association Limited (1989)
Saurashtra Kutch Stock Exchange Limited (at Rajkot 1989)
Vadodara Stock Exchange Limited (at Baroda 1990)
Coimbatore Stock Exchange
Meerut Stock Exchange
At present there are twenty one recognized stock exchanges in India which does not
include the Over The Counter Exchange of India Limited (OTCEI) and the National
Stock Exchange of India Limited (NSEIL)
Government policies during 1980s also played a vital role in the development of the
Indian Stock Markets There was a sharp increase in number of Exchanges listed
companies as well as their capital which is visible from the following table
Table 23 Pattern of Growth of Stock Exchanges
Source SEBI annual report
273 Trading Pattern of the Indian Stock Market
Indian Stock Exchanges allow trading of securities of only those public limited
companies that are listed on the Exchange(s) They are divided into two categories
S
No
As on 31st December 1946 1961 1971 1980 1991 1995 2000 2005
1 No of Stock Exchanges 7 7 8 9 20 22 23 23
2 No of Listed Cos 1125 1203 1599 2265 6229 8593 9413 4731
5 Market value of Capital
of Listed Cos (Cr Rs)
971 1292 2675 6750 110279 478121 6319212 478121
34
Chart 25 Trading Pattern of the Indian Stock Market
Source wwwbseindiacom
274 Types of Transactions
The flowchart below describes the types of transactions that can be carried out on the
Indian stock exchanges
Chart 26 Types of Transactions
Source wwwbseindiacom
Listed Securities of Public limited companies
Specified securities (forward List)
Equity shares of company that are
- Dividend paying
- growth orinted companies
- paid up capital of atleast Rs50 million
- Market capitalisation of atleast Rs100 million
- has more than 20000 shareholders
Non specicied Securities (Cash List)
equity shares of companies not covered in specified securities
Transactions on Indian Stock Exchanges
Spot Delivery Transactions
Forward Transactions
35
Spot Delivery Transactions
Includes transactions that require delivery and payment within stipulated time
period at the time of entering into the contract
This period shall not be more than 14 days following the date of the contract
Forward Transactions
Transactions in which delivery and payment can be extended by further period
of 14 days each
The overall period should not exceed 90 days from the date of contract
Transactions permitted only in case of specified shares
275 Indian stock exchange allows a member broker to perform
following activities
Act as an agent
Buy and sell securities for clients and charge commission for the same
Act as a trader or dealer as a principal
Buy and sell securities on their account and risk
276 Over The Counter Exchange of India (OTCEI)
Traditionally trading in Stock Exchanges in India followed a conventional style
where people used to gather at the Exchange and bids and offers were made by open
outcry This age-old trading mechanism in the Indian stock markets used to create
much functional inefficiency Lack of liquidity and transparency long settlement
periods and benami transactions are a few examples that adversely affected investors
In order to overcome these inefficiencies OTCEI was incorporated in 1990 under the
Companies Act 1956 OTCEI is the first screen based nationwide stock exchange in
India created by Unit Trust of India Industrial Credit and Investment Corporation of
India Industrial Development Bank of India SBI Capital Markets Industrial Finance
Corporation of India General Insurance Corporation and its subsidiaries and Can
Bank Financial Services
36
Chart 27 Securities traded on the OTCEI
Source wwwbseindiacom
Listed Securities
Securities of the companies listed on the OTC
Can be bought or sold at any OTC counter across India
Should not be listed anywhere else
Permitted Securities
Certain securities (Shares and debentures listed on other exchanges)
Unites of Mutual funds can be traded
Initiated Debentures
An equity holding a minimum of one lakh debentures of a particular scrip can
offer them for trading on the OTC
Advantages of OTCEI
Greater liquidity and lesser risk of intermediary charges due to widely spread trading
mechanism across India The screen-based scrip less trading ensures transparency and
accuracy of prices Faster settlement and transfer process as compared to other
exchanges Shorter allotment procedure (in case of a new issue) than other exchanges
277 National Stock Exchange
In order to lift the Indian stock market trading system at par with the international
standards On the basis of the recommendations of high powered Pherwani
Securities teaded on the
OTCEI
Listed Securities
Permitted Securities
Initiated Debentures
37
Committee the National Stock Exchange was incorporated in 1992 by Industrial
Development Bank of India Industrial Credit and Investment Corporation of India
Industrial Finance Corporation of India all Insurance Corporations selected
commercial banks and others
2771 NSE provides exposure to investors in two types of markets
namely
Wholesale debt market
Capital market
Wholesale Debt Market - Similar to money market operations debt market
operations involve institutional investors and corporate bodies entering into
transactions of high value in financial instruments like treasury bills government
securities commercial papers etc
Capital market- A capital market is a market for securities (debt or equity) where
business enterprises and governments can raise long term funds It is defined as a
market in which money is defined as a market in which money is provided for periods
longer than a year34 as the raising of short term funds takes place on other markets
Capital markets may be classified as primary markets and secondary markets In
primary markets new stock or bond issues are sold to investors via a mechanism
known as underwriting In the secondary markets existing securities are sold and
bought among investors or traders usually on a securities exchange over the counter
or elsewhere
278 Trading at NSE amp BSE
Fully automated screen-based trading mechanism
Strictly follows the principle of an order-driven market
Trading members are linked through a communication network
34 Steven M Sheffrin (2003) Economics Principles in action Upper Saddle River Pearson Prentice
Hall
38
This network allows them to execute trade from their offices
The prices at which the buyer and seller are willing to transact will appear on
the screen
When the prices match the transaction will be completed
A confirmation slip will be printed at the office of the trading member
2781 Advantages of trading at NSE amp BSE
Integrated network for trading in stock market of India
Fully automated screen based system that provides higher degree of
transparency
Investors can transact from any part of the country at uniform prices
Greater functional efficiency supported by totally computerized network
28 THE BOMBAY STOCK EXCHANGE
Formerly the Stock Exchange Mumbai popularly called Bombay Stock Exchange
or BSE is the oldest stock exchange in Asia and has the greatest number of listed
companies in the world with 4700 listed as of August 2007 35
It is located at Dalal Street Mumbai India On 31 December 2007 the equity market
capitalization of the BSE was US $ 179 trillion making it the largest stock exchange
in South Asia and the 12th largest in the world
With over 4700 Indian companies list on the stock exchange [10]
and it has a
significant trading volume The BSE SENSEX (SENSITIVE INDEX) also called the
―BSE 30 is a widely used market index in India and Asia Though many other
exchanges exist BSE and the National Stock Exchange of India account for most of
the trading in shares in India
35 World Federation of Exchanges (2007) wwwworld-exchangesorg
39
281 History of the Bombay Stock exchange
Trading in securities has been in vogue in India for a little over 200 years Trading in
securities dates back 1793 most of them being transactions in loan securities of the
East India Company The broking community prospered as there was a rise in prices
which led to a share mania during 1861-65 This bubble burst in 1865 when the
American Civil War ended The brokers realized that investor confidence in the
securities market could be sustained only by organizing themselves into a regulated
body with defined rules and regulations The realization resulted in formation of ―The
Native Share and Stock Brokerslsquo Association which later came to be known as the
Bombay Stock Exchange In 1875 these brokers assembled at a place now called
Dalal Street
The Bombay Stock Exchange is a voluntary nonprofit making association of broker
members It emerged as a premier stock exchange after the 1960 The increased pace
of industrialization caused by the two world wars protection to the domestic industry
and the governmentlsquos fiscal policies aided the growth of new issues which in turn
helped the BSE to prosper The BSE dominated the Indian Capital Market by
accounting for more than 60 per cent of the all Indian turn over
Until 1992 the BSE operated like a closed club of selected members With the
securities scam outburst in 1992 and the SEBI taking over the rains of the Stock
Market the BSE had to bring about changes in its operational policies Until March
1995 the BSE had an open outcry system of trading However when faced with stiff
competition from NSE the countrylsquos first modern computerized and professionally
managed stock exchange set up in 1994 the BSE had to change its system of trading
and operation
On 14 March 1995 the BSE turned to electronic trading whereby brokers trade using
computers This system is known as the BSE On-line Trading System (BOLT)
The introduction of BOLT helped in improving trading volumes significantly
reducing the spread between buy and sell orders better trading in odd lot shares fixed
income instruments and dealings in the renunciation of rights shares
40
In 1995 BOLT was limited to Mumbai whereas the NSE was operating at the
national level As a result the BSE submitted a proposal for allowing installation of
terminals connected to BOLT in centers outside Mumbai After rejecting the proposal
four times on 29 october 1996 the SEBI finally allowed the BSE to use its BOLT
system nationwide Later the BSE set up a central depository system to dematerialize
shares and promote demate Account (trading)
282 Hours of Operation
Beginning of the Day Session 800 to 900
Trading Session 900 to 1530
Position Transfer Session 1530 to 1550
Closing Session 1550 to 1605
Option Exercise Session 1605 to 1635
Margin Session 1635 to 1650
Query Session 1650 to1735
End of Day Session 1735
The hours of operation for the BSE quoted above are stated in terms of the local time
(ie GMT+530) in Mumbai India
BSElsquos normal trading sessions are on all days of the week except Saturdays Sundays
and Holidays declared by the Exchange in advance 36
283 Services of BSE
BSE also had a wide range of services to empower investors and facilitate smooth
transactions These services are as follows
2831 Investor Services
The Dept of investor services redresses grievances of investors BSE was the first
exchange in the country to provide an amount of Rs 1 million towards the investor
36 Asia Technical Analysis with Phil Smith wwwreutersindianet
41
protection fund it is an amount higher than that of any exchange in the country BSE
launched a nationwide investor awareness program ―Safe Investing in the Stock
Market under which 264 programmers were held in more than 200 cities
2832 The BSE Online Trading (BOLT)
BSE on line Trading (BOLT) facilities on-line screen based trading in securities
BOLT is currently operating in 25000 trader work stations located across over 399
cities in India
2833 BSEWEBXcom
In February 2001 BSE introduced the worldlsquos first centralized exchange based
Internet trading system BSEWEBXcom This initiative enables investors anywhere
in the world to trade on BSE platform
2834 Surveillance
BSElsquos Online Surveillance System (BOSS) monitors on a real time basis the price
movements volume position and real time measurements of the default risk market
reconstruct and generation of cross market alerts
2835 BSE Training Institute
BTI imparts capital market training and certification in collaboration with reputed
management institutes and universities It offers over 40 courses on various aspects of
the capital mark and financial sector More than 20000 people have attended the BTI
program
284 Awards
Fowling awards were given to BSE
The world council of Corporate Governance has awarded the Golden Peacock
Global CSR Award for BSElsquos initiatives in corporate social responsibility
The Annual Reports and Accounts of BSE for the year ended March 312006 and
42
March 312007 have been awarded the ICAI awards for excellence in financial
reporting
The Human Resource Management at BSE has won the Asia-Pacific HRM awards
for its efforts in employer branding through talent management at work health
management at work and excellence in HR through technology
Drawing from its rich past and its equally robust performance in the recent times
BSE will continue to remain an icon in the Indian Capital Market
285 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 days closing price is taken for computation of Index closure
The use of Index Closure Algorithm prevents any intentional manipulation of the
closing index value
286 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 affect the
index values The BSE Index Cell does the day-to-day maintenance of the index
within the broad index policy framework set by the BSE Index Committee The BSE
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 BSE Index Committee comprises
of capital market expert fund managers market participants and members of the BSE
Governing Board
43
287 On-Line Computation of the Index
During trading hours value of the Index is calculated and disseminated on real time
basis This is done automatically on the basis of prices at which trades in Index
constituents are executed
288 Adjustment for Bonus Rights and Newly Issued Capital
SENSEX calculation needs to be adjusted for issue of Bonus or 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 BSE Index Cell the base value is adjusted which is used to alter
market capitalization of the component stocks to arrive at the SENSEX value The
BSE Index Cell keeps a close watch on the events that might affect the index on a
regular basis and carries out daily maintenance of all the 19 Indices
2881 Adjustments for Rights Issues
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 (ex-right) price An offsetting or
proportionate adjustment is then made to the Base Market capitalization
2882 Adjustments for Bonus Issue
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
2883 Other Issues 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
buy-back of shares corporate restructuring etc
44
289 Listing Categories
Before badla was resumed in 1996 there were only two categories of securities listed
on the BSE the specified group of shares comprising The securities in which carry
forward deals were allowed and the cash group shares in which no carry forward deals
were permitted Later it was observed that the facility of carry forward was not being
used in all the 94 scrips in the specified group Hence after badla was resumed the
size of the specified group was reduced to 32 scrips on 3 April 1996 The BSE later
decided to regroup the existing A and B group shares into three categories The BSE
delisted 637 companies for a period of 3 years during 2004-05 for non-compliance of
listing agreements
A Group This group consists of large stock with turnover and high floating stock
with large market capitalization In other words scrips with more liquidity and high
networth are included in this group At present there are 150 scrips in this group
B1 Group This group includes scrips of quality companies with equity above Rs 3
crore with high growth potential and trading frequency No carry forward facility was
allowed in this group in June 2000 there were 1803 scrips in this group
B2 Group Scrips in this group were just like those of B1 but with fortnightly
settlement However in September 1996 the BSE introduced weekly settlement for all
scrips listed on the exchange thus doing away with the distinction between the B1 and
B2 groups On June 2000 there were 3219 scrips in this group
Z Group Subsequently a Z group was introduced in 1999 with scrips of companies
that do not meet the rules regulations and stipulations laid down by the exchange It
is a buyer beware company These are some 300 scrips in the group All Z category
stocks result in delivers
F Group A new Flsquo group pertaining to debt market segment was started with effect
from 9 September 1996
S Group The BSE reduced post-public issue capital base requirement from Rs10
crore to Rs3 crore to attract listing by companies with a smaller capital base It also
45
started a new trading segment small cap stock segment known as the Slsquo segment
Corporate with minimum turnover of an equal amount would be eligible to list scrips
on this segment In addition stocks listed on the regional exchanges would also be
able to list on the lsquoSlsquo segment subject to meeting certain criteria
2810 Base Market capitalization Adjustment
The formula for adjusting the Base Market capitalization is as follows
New Base Market Capitalization (NBMC)
New Market capitalization
NBMC = Old Base Market capitalization x mdashmdashmdashmdashmdashmdashmdashmdashmdashmdashmdash
Old Market capitalization
To illustrate suppose a company issues right shares which increases the market
capitalization of the shares of that company by say Rs100 crores The existing Base
Market capitalization (Old Base Market capitalization) say is Rs2450 crores and the
aggregate market capitalization of all the shares included in the index before the right
issue is made is say Rs4781 crore The New Base Market capitalization will then
be
2450x (4781+100)
_____________________ = Rs250124 crores
4781
This figure of Rs 250124 crore will be used as the Base Market capitalization for
calculating the index number from then onwards till the next base change becomes
necessary
Index Review Frequency
The BSE 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
29 STOCK MARKET INDEX
The stock market index is the most important indices of all as it measures overall
market sentiment through a set of stocks that representative of the market The stock
46
market index is a barometer of the market behavior It reflects direction and indicates
day-to-day fluctuations in stock prices The market index reflects expectations about
the behavior of the economy as a whole It is a precursor of economic cycles The
function of a stock index is to provide investors with information regarding the
average share price in the market An ideal index must represent changes in the prices
of the scrips and reflect price movements of typical shares for better market
representation Stock index is a barometer of a nationlsquos economic health as market
prices reflect expectations about the economylsquos performance Stock indices termed as
leading economic as they indicate what is going to happen in the economy in the
future The returns generated in the stock market are based on future expectations A
good market index incorporates a set of scrips which have high market capitalization
and high liquidity Market capitalization is the sum of the market value of all the
stocks included in the index The market value is derived by multiplying the price of
the share outstanding In other words the bid-ask spread is minimum The index on a
day is calculated as the percentage of the aggregate market value of the set of scrips
incorporated in the index on that day to the average market value of the same scrips
during the base period
291 Definition of an Index
A price index is such as the stock market price of the individual securities in the
market It reflects the overall price or return movements of a group of securities
Movements in an index are determined by sample weighting and computational
procedure Sample is normally generated by random selection or try a non random
selection technique designed to incorporate desired characteristics are used to select
sample shares rather than by completely random selection Major criteria for selection
are market activity due representation to various industrial groups and to major stock
exchanges
292 Global Stock Market Indices
2921 The Dow Jones Industrial averagersquos
It is the most widely watched and quoted index because of its long existence The
Dow has 30 constituents and it follows the methodology of price based weighted
47
Changes to stocks included in the Dow are infrequent three stocks were
addeddropped in 1991 four in 1997 and four in 1999 The addition of Microsoft and
Intel in 1999 was the first inclusion of Nasdaq market stocks to the Dow 30
2922 The Nasdaq composite index
The index is the market capitalization weighted of prices for all the stocks listed in the
Nasdaq stock market The Nasdaq composite began on 8 February 1971 with a base
of 100
2923 The Nasdaq 100 index
Nasdaq 100 comprises the largest computer software and telecom stocks by market
capitalization on the Nasdaq For a company to be included in the Nasdaq 100 it must
have a minimum average trading volume of 100000 shares per day and must have
been trading on a major exchange for at least a year or two
2924 The S amp P 500 index
This index comprises 500 biggest publicly traded companies in the US by market
capitalization Most money managers treat the S amp P 500 as a proxy for the US stock
market The S amp P 500 tries to cover all major areas of US economy To be included a
company must be profitable the prospective company must not be closely hold and
must have a large trading volume for its shares
2925 The FTSE 100
The FTSE 100 consists of the largest 100 companies by full market Value listed on
the London Stock Exchange The FTSE 100 is the benchmark index to indicate the
performance of the European market It is a market capitalization weighted index that
also considers the free float weighted of individual stocks before including them in
the index
2926 The MSCI Indices
Include the MSCIEAFE (Europe Australia and Far East) MSCI Europe MSCI
world MSCI (EMF) and MSCI Pacific Basin Indices
48
The MSCI world Index is a free float adjusted market capitalization index that is
designed to measure global developed market equity performance As of April 2002
the MSCI world Index consisted of the MSCI world Index consisted of the following
23 developed market country indices
Australia Austria Belgium Canada Denmark Finland France Germany Greece
Hong Kong Ireland Italy Japan Netherlands New Zealand Norway Singapore
Portugal Spain Sweden Switzerland United Kingdom and the United States of
America
293 Methodology for Calculating The Index
2931 Price Weighted Index
In this method the price of each stock in the index is summed up which is then
equated to an index starting value An arbitrary date is set as the base and the
Laspeyerlsquos Price Index which measures price changes against a fixed base period
quantity weight is used In case of a stock split the market price of the stock falls and
these results in less weighted in the index The Dow Jones Industrial Average and
Nikkie 225 are price-weighted indices
2932 Equal Weighting
In this method each stocklsquos percentage weight in the index is equal and hence all
stocks have an equal influence on the index movement The value line index at
Kansas City Board of Trade (KCBT) is an equal weighted index
2933 Market Capitalization Weighted
29331 Full Market Capitalization Method
In this method the number of shares outstanding multiplied by the market price of a
companylsquos share determines the scriplsquos weighted in the index The shares with the
highest market capitalization would have a higher weighted and would be most
influential in this type of index Eg S amp P 500 Index in USA and S amp P CNX Nify in
India
49
29332 Modified Capitalization Weighted
This method seeks to limit the influence of the largest stocks in the index which
otherwise would dominate the entire index This method sets a limit on the largest
stock or a group of stocks The NASDAQ 100 Index is calculated by using this
method
294 Free Float Market Capitalization Method
2941 Concept
Free float methodology refers to an index construction methodology that takes in to
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 Strategic holding government 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
All BSE indices with exception of BSE-PSU index have adopted the free-float
methodology
2942 Definition of Free Float
Share holding of investor that would not in the normal course come into the
open market for trading are treated as ―Controlling Strategic Holding and
hence not included in free float specifically the following categories of
holding are generally excluded from the definition of free float
Shares hold by foundersdirectorsacquires which has control element
Shares held by person with ―Controlling Interestlsquo
Shares held by Govt as promoters
50
Holding through the FDI Route
Strategic Stakes by private corporate bodiesindividuals
Equity held by employee welfare trusts
Locked-in-shares and shares which not be sold in the open market in normal
course
2943 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-agrave-Vis an investible
index This enables an apple-to-apple comparison thereby facilitating better
evaluation of performance of active managers
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 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
The free float methodology of index construction is considered to be an industry best
practice and all major index providers like MSCI FTSE SampP 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
51
29441 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 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 055 means that only 55 of the market
capitalization of the company will be considered for index calculation
Table 24 Free-float Bands
Free-Float Free-Float Factor Free-Float Free-Float Factor
gt0 - 5 005 gt50 - 55 055
gt5 - 10 010 gt55 - 60 060
gt10 - 15 015 gt60 - 65 065
gt15 - 20 020 gt65 - 70 070
gt20 - 25 025 gt70 - 75 075
gt25 - 30 030 gt75 - 80 080
gt30 - 35 035 gt80 - 85 085
gt35 - 40 040 gt85 - 90 090
gt40 - 45 045 gt90 - 95 095
gt45 - 50 050 gt95 - 100 100
Source wwwbseindiacom
295 BSE Indices
For the premier stock exchange that pioneered the securities transaction business
in India over a century of experience is a proud achievement A lot has changed since
1875 when 318 persons by paying a then princely amount of Re 1 became members
of what today is called Bombay Stock Exchange Limited (BSE) Over the decades
the stock market in the country has passed through good and bad periods The journey
52
in the 20th century has not been an easy one Till the decade of eighties there was no
measure or scale that could precisely measure the various ups and downs in the Indian
stock market BSE in 1986 came out with a Stock Index-SENSEX- that subsequently
became the barometer of the Indian stock market
The launch of SENSEX in 1986 was later followed up in January 1989 by
introduction of BSE National Index (Base 1983-84 = 100) It comprised 100 stocks
listed at five major stock exchanges in India - Mumbai Calcutta Delhi Ahmadabad
and Madras The BSE National Index was renamed BSE-100 Index from October 14
1996 and since then it is being calculated taking into consideration only the prices of
stocks listed at BSE BSE launched the dollar-linked version of BSE-100 index on
May 22 2006
With a view to provide a better representation of the increasing number of listed
companies larger market capitalization and the new industry sectors BSE launched
on 27th May 1994 two new index series viz the BSE-200 and the DOLLEX-200
Since then BSE has come a long way in attuning itself to the varied needs of
investors and market participants In order to fulfill the need for still broader
segment-specific and sector-specific indices BSE has continuously been increasing
the range of its indices BSE-500 Index and 5 sectorial indices were launched in 1999
In 2001 BSE launched BSE-PSU Index DOLLEX-30 and the countrys first free-
float based index - the BSE TEC Index Over the years BSE shifted all its indices to
the free-float methodology
BSE disseminates information on the Price-Earnings Ratio the Price to Book Value
Ratio and the Dividend Yield Percentage on day-to-day basis of all its major indices
The values of all BSE indices are updated on real time basis during market hours and
displayed through the BOLT system BSE website and news wire agencies
All BSE Indices are reviewed periodically by the BSE Index Committee This
Committee which comprises eminent independent finance professionals frames the
broad policy guidelines for the development and maintenance of all BSE indices The
BSE Index Cell carries out the day-to-day maintenance of all indices and conducts
research on development of new indices
53
2951 BSE-100 Index
A broad-based index the BSE-100 was formerly known as the BSE National index
This Index has 1983-84 as the base year and was launched in 1989 In line with the
shift of the BSE Indices to the globally accepted Free-Float methodology BSE-100
was shifted to Free-Float methodology effective from April 5 2004 The method of
computation of Free-Float index and determination of free-float factors is similar to
the methodology for SENSEX
Table 25 Index Specification
Base Year 1983-84
Base Index Value 100
Date of Launch 3-Jan-89
Method of calculation Launched on full market capitalization
method and effective April 05 2004
calculation method shifted to free-float
market capitalization
Number of scrips 100
Index calculation frequency Real Time
Source wwwbseindiacom
2952 Base Year
The financial year 1983-84 has been chosen as the base year The price stability
during that year and proximity to the index series were the main consideration for
choice of 1983-84 as the base year The base value was fixed at 100 points
2953 Dollex-100
BSE also calculates a dollar-linked version of SENSEX and historical values of this
index are available since its inception
2954 BSE-100 index - Scrip Selection Criteria
The general guidelines for selection of constituents in BSE-100 are as follows
Trading Frequency The scrip should have been traded on 95 of the trading days
54
in the last three months Exceptions can be made for extreme reasons like scrip
suspension etc
Final Rank The scrip should figure in the top 200 companies listed by final rank
The final rank is arrived at by assigning 75 weighted to the rank on the basis of
three-month average full market capitalization and 25 weighted to the liquidity rank
based on three-month average daily turnover amp three-month average impact cost
IndustrySector Representation Scrip selection would generally take into account a
balanced sectorial representation of the listed companies in the universe of BSE
Track Record In the opinion of the BSE Index Committee the company should
have an acceptable track record
210 STOCK MARKET VOLATILITY
2101 Meaning
Volatility is a measure for variation of price of a financial instrument over time
Historic volatility is derived from time series of past market prices An implied
volatility is derived from the market price of a market traded derivative (in particular
an option) Volatility does not measure the direction of price changes merely their
dispersion This is because when calculating standard deviation (or variance) all
differences are squared so that negative and positive differences are combined into
one quantity Two instruments with different volatilities may have the same expected
return but the instrument with higher volatility will have larger swings in values over
a given period of time
For example a lower volatility stock may have an expected (average) return of 7
with annual volatility of 5 This would indicate returns from approximately negative
3 to positive 17 most of the time (19 times out of 20 or 95 via a two standard
deviation rule) A higher volatility stock with the same expected return of 7 but
with annual volatility of 20 would indicate returns from approximately negative
33 to positive 47 most of the time (19 times out of 20 or 95) These estimates
assume a normal distribution in reality stocks are found to be leptokurtotic
55
2102 Terminology used in volatility
Volatility as described here refers to the actual current volatility of a financial
instrument for a specified period (for example 30 days or 90 days) It is the volatility
of a financial instrument based on historical prices over the specified period with the
last observation the most recent price This phrase is used particularly when it is
wished to distinguish between the actual current volatility of an instrument and
actual historical volatility which refers to the volatility of a financial instrument
over a specified period but with the last observation on a date in the past
actual future volatility which refers to the volatility of a financial instrument
over a specified period starting at the current time and ending at a future date
(normally the expiry date of an options)
historical implied volatility which refers to the implied volatility observed from
historical prices of the financial instrument (normally options)
current implied volatility which refers to the implied volatility observed from
current prices of the financial instrument
future implied volatility which refers to the implied volatility observed from
future prices of the financial instrument
For a financial instrument whose price follows a random walk or wiener process the
width of the distribution increases as time increases This is because there is an
increasing profitability that the instruments price will be farther away from the initial
price as time increases However rather than increase linearly the volatility increases
with the square-root of time as time increases because some fluctuations are expected
to cancel each other out so the most likely deviation after twice the time will not be
twice the distance from zero
2103 Usefulness of volatility for Investors
Investors care about volatility for five reasons
1 The wider the swings in an investments price the harder emotionally it is to
not worry
2 Price volatility of a trading instrument can define position sizing in a portfolio
56
3 When certain cash flows from selling a security are needed at a specific future
date higher volatility means a greater chance of a shortfall
4 Higher volatility of returns while saving for retirement results in a wider
distribution of possible final portfolio values
5 Higher volatility of return when retired gives withdrawals a larger permanent
impact on the portfolios value
6 Price volatility presents opportunities to buy assets cheaply and sell when
overpriced
30
products such as interest rates and shares as well as Options contracts They are now
generally known as futures exchanges
26 OWNERSHIP
Stock exchanges originated as mutual organizations owned by its member stock
brokers There has been a recent trend for stock exchanges to demutualize where the
members sell their shares in an initial public offering In this way the mutual
organization becomes a corporation with shares that are listed on a stock exchange
Examples are
Australian Securities Exchange (1998) Euro next (merged with New York Stock
Exchange) NASDAQ (2002) The New York Stock Exchange (2005) Bolsas
Mercados Espanoles and the Sao Paulo Stock Exchange (2007) The Shenzhen and
Shanghai stock exchanges can be characterized as quasi-state institutions insofar as
they were created by government bodies in China and their leading personnel are
directly appointed by the China Securities Regulatory Commission
27 HISTORY OF INDIAN STOCK MARKET
The stock exchange in Mumbai is more than 100 years old The origin of the stock
market in India dates back to the end of the eighteenth century when long term
negotiable securities were first issued The real beginning however occurred in the
middle of the nine teeth century after the enactment of the Companies Act in 1850
which introduced the feature of limited liability and generated investor interest in
corporate securities
The Native Share and Stock Brokerslsquo Association now known as the Bombay Stock
Exchange (BSE) was formed in Bombay (now Mumbai) in 1875 This was followed
by the formation of association in Ahmadabad in 1894 Calcutta (now Kolkata) in
1908 and Madras (now Chennai) in 1937 In order to promote the orderly
development of the stock market the central government introduced a comprehensive
legislation called the Securities Contracts (Regulation) Act 1956
31
The Calcutta Stock Exchange (CSE) was the largest stock exchange in India till the
1960s In 1961 there were 1203 listed companies across the various stock exchanges
of the country Of these 576 were listed on the CSE and 297 on the BSE However
during the later half of the 1960s the relative importance of the CSE declined while
that of the BSE increased sharply
One of the oldest stock markets in Asia the Indian Stock Markets have a 200 years
old history
Table 22 Origin of Indian Stock Market
Year Events
18th
Century
East India Company was the dominant institution and by end of the century business in its loan
securities gained full momentum
1830s Business on corporate stocks and shares in Bank and Cotton presses started in Bombay Trading list
by the end of 1839 got broader
1840s Recognition from banks and merchants to about half a dozen brokers
1850s Rapid development of commercial enterprise saw brokerage business attracting more people into
the business
1860s The number of brokers increased to 60
1860-61 The American Civil War broke out which caused a stoppage of cotton supply from United States of
America marking the beginning of the Share Mania in India
1862-63 The number of brokers increased to about 200 to 250
1865 A disastrous slump began at the end of the American Civil War (as an example Bank of Bombay
Share which had touched Rs 2850 could only be sold at Rs 87)
1874 With the rapidly developing share trading business brokers used to gather at a street (now well
known as Dalal Street) for the purpose of transacting business
1875 The Native Share and Stock Brokers Association (also known as The Bombay Stock
Exchange) was established in Bombay
1880s Development of cotton mills industry and set up of many others
1894 Establishment of The Ahmadabad Share and Stock Brokers Association
1880 -
90s
Sharp increase in share prices of jute industries in 1870s was followed by a boom in tea stocks and
coal
1908 The Calcutta Stock Exchange Association was formed
1920 Madras witnessed boom and business at The Madras Stock Exchange was transacted with 100
brokers
1923 When recession followed number of brokers came down to 3 and the Exchange was closed down
32
1934 Establishment of the Lahore Stock Exchange
1936 Merger of the Lahore Stock Exchange with the Punjab Stock Exchange
1937 Re-organization and set up of the Madras Stock Exchange Limited (Pvt) Limited led by
improvement in stock market activities in South India with establishment of new textile mills and
plantation companies
1940 Uttar Pradesh Stock Exchange Limited and Nagpur Stock Exchange Limited was established
1944 Establishment of The Hyderabad Stock Exchange Limited
1947 Delhi Stock and Share Brokers Association Limited and The Delhi Stocks and Shares Exchange
Limited were established and later on merged into The Delhi Stock Exchange Association
Limited
Sources wwwsurfindiacom wwwappuonlinecom
271 Post Independence Scenario
The depression witnessed after the Independence led to closure of a lot of exchanges
in the country Lahore Stock Exchange was closed down after the partition of India
and later on merged with the Delhi Stock Exchange Bangalore Stock Exchange
Limited was registered in 1957 and got recognition only by 1963 Most of the other
Exchanges were in a miserable state till 1957 when they applied for recognition under
Securities Contracts (Regulations) Act 1956 The Exchanges that were recognized
under the Act were
Bombay Calcutta Madras Ahmadabad Delhi Hyderabad Bangalore Indore
272 Many more stock exchanges were established during 1980s
namely
Cochin Stock Exchange (1980)
Uttar Pradesh Stock Exchange Association Limited (at Kanpur 1982)
Pune Stock Exchange Limited (1982)
Ludhiana Stock Exchange Association Limited (1983)
Gauhati Stock Exchange Limited (1984)
Kanara Stock Exchange Limited (at Mangalore 1985)
33
Magadh Stock Exchange Association (at Patna 1986)
Jaipur Stock Exchange Limited (1989)
Bhubaneswar Stock Exchange Association Limited (1989)
Saurashtra Kutch Stock Exchange Limited (at Rajkot 1989)
Vadodara Stock Exchange Limited (at Baroda 1990)
Coimbatore Stock Exchange
Meerut Stock Exchange
At present there are twenty one recognized stock exchanges in India which does not
include the Over The Counter Exchange of India Limited (OTCEI) and the National
Stock Exchange of India Limited (NSEIL)
Government policies during 1980s also played a vital role in the development of the
Indian Stock Markets There was a sharp increase in number of Exchanges listed
companies as well as their capital which is visible from the following table
Table 23 Pattern of Growth of Stock Exchanges
Source SEBI annual report
273 Trading Pattern of the Indian Stock Market
Indian Stock Exchanges allow trading of securities of only those public limited
companies that are listed on the Exchange(s) They are divided into two categories
S
No
As on 31st December 1946 1961 1971 1980 1991 1995 2000 2005
1 No of Stock Exchanges 7 7 8 9 20 22 23 23
2 No of Listed Cos 1125 1203 1599 2265 6229 8593 9413 4731
5 Market value of Capital
of Listed Cos (Cr Rs)
971 1292 2675 6750 110279 478121 6319212 478121
34
Chart 25 Trading Pattern of the Indian Stock Market
Source wwwbseindiacom
274 Types of Transactions
The flowchart below describes the types of transactions that can be carried out on the
Indian stock exchanges
Chart 26 Types of Transactions
Source wwwbseindiacom
Listed Securities of Public limited companies
Specified securities (forward List)
Equity shares of company that are
- Dividend paying
- growth orinted companies
- paid up capital of atleast Rs50 million
- Market capitalisation of atleast Rs100 million
- has more than 20000 shareholders
Non specicied Securities (Cash List)
equity shares of companies not covered in specified securities
Transactions on Indian Stock Exchanges
Spot Delivery Transactions
Forward Transactions
35
Spot Delivery Transactions
Includes transactions that require delivery and payment within stipulated time
period at the time of entering into the contract
This period shall not be more than 14 days following the date of the contract
Forward Transactions
Transactions in which delivery and payment can be extended by further period
of 14 days each
The overall period should not exceed 90 days from the date of contract
Transactions permitted only in case of specified shares
275 Indian stock exchange allows a member broker to perform
following activities
Act as an agent
Buy and sell securities for clients and charge commission for the same
Act as a trader or dealer as a principal
Buy and sell securities on their account and risk
276 Over The Counter Exchange of India (OTCEI)
Traditionally trading in Stock Exchanges in India followed a conventional style
where people used to gather at the Exchange and bids and offers were made by open
outcry This age-old trading mechanism in the Indian stock markets used to create
much functional inefficiency Lack of liquidity and transparency long settlement
periods and benami transactions are a few examples that adversely affected investors
In order to overcome these inefficiencies OTCEI was incorporated in 1990 under the
Companies Act 1956 OTCEI is the first screen based nationwide stock exchange in
India created by Unit Trust of India Industrial Credit and Investment Corporation of
India Industrial Development Bank of India SBI Capital Markets Industrial Finance
Corporation of India General Insurance Corporation and its subsidiaries and Can
Bank Financial Services
36
Chart 27 Securities traded on the OTCEI
Source wwwbseindiacom
Listed Securities
Securities of the companies listed on the OTC
Can be bought or sold at any OTC counter across India
Should not be listed anywhere else
Permitted Securities
Certain securities (Shares and debentures listed on other exchanges)
Unites of Mutual funds can be traded
Initiated Debentures
An equity holding a minimum of one lakh debentures of a particular scrip can
offer them for trading on the OTC
Advantages of OTCEI
Greater liquidity and lesser risk of intermediary charges due to widely spread trading
mechanism across India The screen-based scrip less trading ensures transparency and
accuracy of prices Faster settlement and transfer process as compared to other
exchanges Shorter allotment procedure (in case of a new issue) than other exchanges
277 National Stock Exchange
In order to lift the Indian stock market trading system at par with the international
standards On the basis of the recommendations of high powered Pherwani
Securities teaded on the
OTCEI
Listed Securities
Permitted Securities
Initiated Debentures
37
Committee the National Stock Exchange was incorporated in 1992 by Industrial
Development Bank of India Industrial Credit and Investment Corporation of India
Industrial Finance Corporation of India all Insurance Corporations selected
commercial banks and others
2771 NSE provides exposure to investors in two types of markets
namely
Wholesale debt market
Capital market
Wholesale Debt Market - Similar to money market operations debt market
operations involve institutional investors and corporate bodies entering into
transactions of high value in financial instruments like treasury bills government
securities commercial papers etc
Capital market- A capital market is a market for securities (debt or equity) where
business enterprises and governments can raise long term funds It is defined as a
market in which money is defined as a market in which money is provided for periods
longer than a year34 as the raising of short term funds takes place on other markets
Capital markets may be classified as primary markets and secondary markets In
primary markets new stock or bond issues are sold to investors via a mechanism
known as underwriting In the secondary markets existing securities are sold and
bought among investors or traders usually on a securities exchange over the counter
or elsewhere
278 Trading at NSE amp BSE
Fully automated screen-based trading mechanism
Strictly follows the principle of an order-driven market
Trading members are linked through a communication network
34 Steven M Sheffrin (2003) Economics Principles in action Upper Saddle River Pearson Prentice
Hall
38
This network allows them to execute trade from their offices
The prices at which the buyer and seller are willing to transact will appear on
the screen
When the prices match the transaction will be completed
A confirmation slip will be printed at the office of the trading member
2781 Advantages of trading at NSE amp BSE
Integrated network for trading in stock market of India
Fully automated screen based system that provides higher degree of
transparency
Investors can transact from any part of the country at uniform prices
Greater functional efficiency supported by totally computerized network
28 THE BOMBAY STOCK EXCHANGE
Formerly the Stock Exchange Mumbai popularly called Bombay Stock Exchange
or BSE is the oldest stock exchange in Asia and has the greatest number of listed
companies in the world with 4700 listed as of August 2007 35
It is located at Dalal Street Mumbai India On 31 December 2007 the equity market
capitalization of the BSE was US $ 179 trillion making it the largest stock exchange
in South Asia and the 12th largest in the world
With over 4700 Indian companies list on the stock exchange [10]
and it has a
significant trading volume The BSE SENSEX (SENSITIVE INDEX) also called the
―BSE 30 is a widely used market index in India and Asia Though many other
exchanges exist BSE and the National Stock Exchange of India account for most of
the trading in shares in India
35 World Federation of Exchanges (2007) wwwworld-exchangesorg
39
281 History of the Bombay Stock exchange
Trading in securities has been in vogue in India for a little over 200 years Trading in
securities dates back 1793 most of them being transactions in loan securities of the
East India Company The broking community prospered as there was a rise in prices
which led to a share mania during 1861-65 This bubble burst in 1865 when the
American Civil War ended The brokers realized that investor confidence in the
securities market could be sustained only by organizing themselves into a regulated
body with defined rules and regulations The realization resulted in formation of ―The
Native Share and Stock Brokerslsquo Association which later came to be known as the
Bombay Stock Exchange In 1875 these brokers assembled at a place now called
Dalal Street
The Bombay Stock Exchange is a voluntary nonprofit making association of broker
members It emerged as a premier stock exchange after the 1960 The increased pace
of industrialization caused by the two world wars protection to the domestic industry
and the governmentlsquos fiscal policies aided the growth of new issues which in turn
helped the BSE to prosper The BSE dominated the Indian Capital Market by
accounting for more than 60 per cent of the all Indian turn over
Until 1992 the BSE operated like a closed club of selected members With the
securities scam outburst in 1992 and the SEBI taking over the rains of the Stock
Market the BSE had to bring about changes in its operational policies Until March
1995 the BSE had an open outcry system of trading However when faced with stiff
competition from NSE the countrylsquos first modern computerized and professionally
managed stock exchange set up in 1994 the BSE had to change its system of trading
and operation
On 14 March 1995 the BSE turned to electronic trading whereby brokers trade using
computers This system is known as the BSE On-line Trading System (BOLT)
The introduction of BOLT helped in improving trading volumes significantly
reducing the spread between buy and sell orders better trading in odd lot shares fixed
income instruments and dealings in the renunciation of rights shares
40
In 1995 BOLT was limited to Mumbai whereas the NSE was operating at the
national level As a result the BSE submitted a proposal for allowing installation of
terminals connected to BOLT in centers outside Mumbai After rejecting the proposal
four times on 29 october 1996 the SEBI finally allowed the BSE to use its BOLT
system nationwide Later the BSE set up a central depository system to dematerialize
shares and promote demate Account (trading)
282 Hours of Operation
Beginning of the Day Session 800 to 900
Trading Session 900 to 1530
Position Transfer Session 1530 to 1550
Closing Session 1550 to 1605
Option Exercise Session 1605 to 1635
Margin Session 1635 to 1650
Query Session 1650 to1735
End of Day Session 1735
The hours of operation for the BSE quoted above are stated in terms of the local time
(ie GMT+530) in Mumbai India
BSElsquos normal trading sessions are on all days of the week except Saturdays Sundays
and Holidays declared by the Exchange in advance 36
283 Services of BSE
BSE also had a wide range of services to empower investors and facilitate smooth
transactions These services are as follows
2831 Investor Services
The Dept of investor services redresses grievances of investors BSE was the first
exchange in the country to provide an amount of Rs 1 million towards the investor
36 Asia Technical Analysis with Phil Smith wwwreutersindianet
41
protection fund it is an amount higher than that of any exchange in the country BSE
launched a nationwide investor awareness program ―Safe Investing in the Stock
Market under which 264 programmers were held in more than 200 cities
2832 The BSE Online Trading (BOLT)
BSE on line Trading (BOLT) facilities on-line screen based trading in securities
BOLT is currently operating in 25000 trader work stations located across over 399
cities in India
2833 BSEWEBXcom
In February 2001 BSE introduced the worldlsquos first centralized exchange based
Internet trading system BSEWEBXcom This initiative enables investors anywhere
in the world to trade on BSE platform
2834 Surveillance
BSElsquos Online Surveillance System (BOSS) monitors on a real time basis the price
movements volume position and real time measurements of the default risk market
reconstruct and generation of cross market alerts
2835 BSE Training Institute
BTI imparts capital market training and certification in collaboration with reputed
management institutes and universities It offers over 40 courses on various aspects of
the capital mark and financial sector More than 20000 people have attended the BTI
program
284 Awards
Fowling awards were given to BSE
The world council of Corporate Governance has awarded the Golden Peacock
Global CSR Award for BSElsquos initiatives in corporate social responsibility
The Annual Reports and Accounts of BSE for the year ended March 312006 and
42
March 312007 have been awarded the ICAI awards for excellence in financial
reporting
The Human Resource Management at BSE has won the Asia-Pacific HRM awards
for its efforts in employer branding through talent management at work health
management at work and excellence in HR through technology
Drawing from its rich past and its equally robust performance in the recent times
BSE will continue to remain an icon in the Indian Capital Market
285 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 days closing price is taken for computation of Index closure
The use of Index Closure Algorithm prevents any intentional manipulation of the
closing index value
286 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 affect the
index values The BSE Index Cell does the day-to-day maintenance of the index
within the broad index policy framework set by the BSE Index Committee The BSE
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 BSE Index Committee comprises
of capital market expert fund managers market participants and members of the BSE
Governing Board
43
287 On-Line Computation of the Index
During trading hours value of the Index is calculated and disseminated on real time
basis This is done automatically on the basis of prices at which trades in Index
constituents are executed
288 Adjustment for Bonus Rights and Newly Issued Capital
SENSEX calculation needs to be adjusted for issue of Bonus or 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 BSE Index Cell the base value is adjusted which is used to alter
market capitalization of the component stocks to arrive at the SENSEX value The
BSE Index Cell keeps a close watch on the events that might affect the index on a
regular basis and carries out daily maintenance of all the 19 Indices
2881 Adjustments for Rights Issues
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 (ex-right) price An offsetting or
proportionate adjustment is then made to the Base Market capitalization
2882 Adjustments for Bonus Issue
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
2883 Other Issues 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
buy-back of shares corporate restructuring etc
44
289 Listing Categories
Before badla was resumed in 1996 there were only two categories of securities listed
on the BSE the specified group of shares comprising The securities in which carry
forward deals were allowed and the cash group shares in which no carry forward deals
were permitted Later it was observed that the facility of carry forward was not being
used in all the 94 scrips in the specified group Hence after badla was resumed the
size of the specified group was reduced to 32 scrips on 3 April 1996 The BSE later
decided to regroup the existing A and B group shares into three categories The BSE
delisted 637 companies for a period of 3 years during 2004-05 for non-compliance of
listing agreements
A Group This group consists of large stock with turnover and high floating stock
with large market capitalization In other words scrips with more liquidity and high
networth are included in this group At present there are 150 scrips in this group
B1 Group This group includes scrips of quality companies with equity above Rs 3
crore with high growth potential and trading frequency No carry forward facility was
allowed in this group in June 2000 there were 1803 scrips in this group
B2 Group Scrips in this group were just like those of B1 but with fortnightly
settlement However in September 1996 the BSE introduced weekly settlement for all
scrips listed on the exchange thus doing away with the distinction between the B1 and
B2 groups On June 2000 there were 3219 scrips in this group
Z Group Subsequently a Z group was introduced in 1999 with scrips of companies
that do not meet the rules regulations and stipulations laid down by the exchange It
is a buyer beware company These are some 300 scrips in the group All Z category
stocks result in delivers
F Group A new Flsquo group pertaining to debt market segment was started with effect
from 9 September 1996
S Group The BSE reduced post-public issue capital base requirement from Rs10
crore to Rs3 crore to attract listing by companies with a smaller capital base It also
45
started a new trading segment small cap stock segment known as the Slsquo segment
Corporate with minimum turnover of an equal amount would be eligible to list scrips
on this segment In addition stocks listed on the regional exchanges would also be
able to list on the lsquoSlsquo segment subject to meeting certain criteria
2810 Base Market capitalization Adjustment
The formula for adjusting the Base Market capitalization is as follows
New Base Market Capitalization (NBMC)
New Market capitalization
NBMC = Old Base Market capitalization x mdashmdashmdashmdashmdashmdashmdashmdashmdashmdashmdash
Old Market capitalization
To illustrate suppose a company issues right shares which increases the market
capitalization of the shares of that company by say Rs100 crores The existing Base
Market capitalization (Old Base Market capitalization) say is Rs2450 crores and the
aggregate market capitalization of all the shares included in the index before the right
issue is made is say Rs4781 crore The New Base Market capitalization will then
be
2450x (4781+100)
_____________________ = Rs250124 crores
4781
This figure of Rs 250124 crore will be used as the Base Market capitalization for
calculating the index number from then onwards till the next base change becomes
necessary
Index Review Frequency
The BSE 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
29 STOCK MARKET INDEX
The stock market index is the most important indices of all as it measures overall
market sentiment through a set of stocks that representative of the market The stock
46
market index is a barometer of the market behavior It reflects direction and indicates
day-to-day fluctuations in stock prices The market index reflects expectations about
the behavior of the economy as a whole It is a precursor of economic cycles The
function of a stock index is to provide investors with information regarding the
average share price in the market An ideal index must represent changes in the prices
of the scrips and reflect price movements of typical shares for better market
representation Stock index is a barometer of a nationlsquos economic health as market
prices reflect expectations about the economylsquos performance Stock indices termed as
leading economic as they indicate what is going to happen in the economy in the
future The returns generated in the stock market are based on future expectations A
good market index incorporates a set of scrips which have high market capitalization
and high liquidity Market capitalization is the sum of the market value of all the
stocks included in the index The market value is derived by multiplying the price of
the share outstanding In other words the bid-ask spread is minimum The index on a
day is calculated as the percentage of the aggregate market value of the set of scrips
incorporated in the index on that day to the average market value of the same scrips
during the base period
291 Definition of an Index
A price index is such as the stock market price of the individual securities in the
market It reflects the overall price or return movements of a group of securities
Movements in an index are determined by sample weighting and computational
procedure Sample is normally generated by random selection or try a non random
selection technique designed to incorporate desired characteristics are used to select
sample shares rather than by completely random selection Major criteria for selection
are market activity due representation to various industrial groups and to major stock
exchanges
292 Global Stock Market Indices
2921 The Dow Jones Industrial averagersquos
It is the most widely watched and quoted index because of its long existence The
Dow has 30 constituents and it follows the methodology of price based weighted
47
Changes to stocks included in the Dow are infrequent three stocks were
addeddropped in 1991 four in 1997 and four in 1999 The addition of Microsoft and
Intel in 1999 was the first inclusion of Nasdaq market stocks to the Dow 30
2922 The Nasdaq composite index
The index is the market capitalization weighted of prices for all the stocks listed in the
Nasdaq stock market The Nasdaq composite began on 8 February 1971 with a base
of 100
2923 The Nasdaq 100 index
Nasdaq 100 comprises the largest computer software and telecom stocks by market
capitalization on the Nasdaq For a company to be included in the Nasdaq 100 it must
have a minimum average trading volume of 100000 shares per day and must have
been trading on a major exchange for at least a year or two
2924 The S amp P 500 index
This index comprises 500 biggest publicly traded companies in the US by market
capitalization Most money managers treat the S amp P 500 as a proxy for the US stock
market The S amp P 500 tries to cover all major areas of US economy To be included a
company must be profitable the prospective company must not be closely hold and
must have a large trading volume for its shares
2925 The FTSE 100
The FTSE 100 consists of the largest 100 companies by full market Value listed on
the London Stock Exchange The FTSE 100 is the benchmark index to indicate the
performance of the European market It is a market capitalization weighted index that
also considers the free float weighted of individual stocks before including them in
the index
2926 The MSCI Indices
Include the MSCIEAFE (Europe Australia and Far East) MSCI Europe MSCI
world MSCI (EMF) and MSCI Pacific Basin Indices
48
The MSCI world Index is a free float adjusted market capitalization index that is
designed to measure global developed market equity performance As of April 2002
the MSCI world Index consisted of the MSCI world Index consisted of the following
23 developed market country indices
Australia Austria Belgium Canada Denmark Finland France Germany Greece
Hong Kong Ireland Italy Japan Netherlands New Zealand Norway Singapore
Portugal Spain Sweden Switzerland United Kingdom and the United States of
America
293 Methodology for Calculating The Index
2931 Price Weighted Index
In this method the price of each stock in the index is summed up which is then
equated to an index starting value An arbitrary date is set as the base and the
Laspeyerlsquos Price Index which measures price changes against a fixed base period
quantity weight is used In case of a stock split the market price of the stock falls and
these results in less weighted in the index The Dow Jones Industrial Average and
Nikkie 225 are price-weighted indices
2932 Equal Weighting
In this method each stocklsquos percentage weight in the index is equal and hence all
stocks have an equal influence on the index movement The value line index at
Kansas City Board of Trade (KCBT) is an equal weighted index
2933 Market Capitalization Weighted
29331 Full Market Capitalization Method
In this method the number of shares outstanding multiplied by the market price of a
companylsquos share determines the scriplsquos weighted in the index The shares with the
highest market capitalization would have a higher weighted and would be most
influential in this type of index Eg S amp P 500 Index in USA and S amp P CNX Nify in
India
49
29332 Modified Capitalization Weighted
This method seeks to limit the influence of the largest stocks in the index which
otherwise would dominate the entire index This method sets a limit on the largest
stock or a group of stocks The NASDAQ 100 Index is calculated by using this
method
294 Free Float Market Capitalization Method
2941 Concept
Free float methodology refers to an index construction methodology that takes in to
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 Strategic holding government 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
All BSE indices with exception of BSE-PSU index have adopted the free-float
methodology
2942 Definition of Free Float
Share holding of investor that would not in the normal course come into the
open market for trading are treated as ―Controlling Strategic Holding and
hence not included in free float specifically the following categories of
holding are generally excluded from the definition of free float
Shares hold by foundersdirectorsacquires which has control element
Shares held by person with ―Controlling Interestlsquo
Shares held by Govt as promoters
50
Holding through the FDI Route
Strategic Stakes by private corporate bodiesindividuals
Equity held by employee welfare trusts
Locked-in-shares and shares which not be sold in the open market in normal
course
2943 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-agrave-Vis an investible
index This enables an apple-to-apple comparison thereby facilitating better
evaluation of performance of active managers
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 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
The free float methodology of index construction is considered to be an industry best
practice and all major index providers like MSCI FTSE SampP 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
51
29441 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 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 055 means that only 55 of the market
capitalization of the company will be considered for index calculation
Table 24 Free-float Bands
Free-Float Free-Float Factor Free-Float Free-Float Factor
gt0 - 5 005 gt50 - 55 055
gt5 - 10 010 gt55 - 60 060
gt10 - 15 015 gt60 - 65 065
gt15 - 20 020 gt65 - 70 070
gt20 - 25 025 gt70 - 75 075
gt25 - 30 030 gt75 - 80 080
gt30 - 35 035 gt80 - 85 085
gt35 - 40 040 gt85 - 90 090
gt40 - 45 045 gt90 - 95 095
gt45 - 50 050 gt95 - 100 100
Source wwwbseindiacom
295 BSE Indices
For the premier stock exchange that pioneered the securities transaction business
in India over a century of experience is a proud achievement A lot has changed since
1875 when 318 persons by paying a then princely amount of Re 1 became members
of what today is called Bombay Stock Exchange Limited (BSE) Over the decades
the stock market in the country has passed through good and bad periods The journey
52
in the 20th century has not been an easy one Till the decade of eighties there was no
measure or scale that could precisely measure the various ups and downs in the Indian
stock market BSE in 1986 came out with a Stock Index-SENSEX- that subsequently
became the barometer of the Indian stock market
The launch of SENSEX in 1986 was later followed up in January 1989 by
introduction of BSE National Index (Base 1983-84 = 100) It comprised 100 stocks
listed at five major stock exchanges in India - Mumbai Calcutta Delhi Ahmadabad
and Madras The BSE National Index was renamed BSE-100 Index from October 14
1996 and since then it is being calculated taking into consideration only the prices of
stocks listed at BSE BSE launched the dollar-linked version of BSE-100 index on
May 22 2006
With a view to provide a better representation of the increasing number of listed
companies larger market capitalization and the new industry sectors BSE launched
on 27th May 1994 two new index series viz the BSE-200 and the DOLLEX-200
Since then BSE has come a long way in attuning itself to the varied needs of
investors and market participants In order to fulfill the need for still broader
segment-specific and sector-specific indices BSE has continuously been increasing
the range of its indices BSE-500 Index and 5 sectorial indices were launched in 1999
In 2001 BSE launched BSE-PSU Index DOLLEX-30 and the countrys first free-
float based index - the BSE TEC Index Over the years BSE shifted all its indices to
the free-float methodology
BSE disseminates information on the Price-Earnings Ratio the Price to Book Value
Ratio and the Dividend Yield Percentage on day-to-day basis of all its major indices
The values of all BSE indices are updated on real time basis during market hours and
displayed through the BOLT system BSE website and news wire agencies
All BSE Indices are reviewed periodically by the BSE Index Committee This
Committee which comprises eminent independent finance professionals frames the
broad policy guidelines for the development and maintenance of all BSE indices The
BSE Index Cell carries out the day-to-day maintenance of all indices and conducts
research on development of new indices
53
2951 BSE-100 Index
A broad-based index the BSE-100 was formerly known as the BSE National index
This Index has 1983-84 as the base year and was launched in 1989 In line with the
shift of the BSE Indices to the globally accepted Free-Float methodology BSE-100
was shifted to Free-Float methodology effective from April 5 2004 The method of
computation of Free-Float index and determination of free-float factors is similar to
the methodology for SENSEX
Table 25 Index Specification
Base Year 1983-84
Base Index Value 100
Date of Launch 3-Jan-89
Method of calculation Launched on full market capitalization
method and effective April 05 2004
calculation method shifted to free-float
market capitalization
Number of scrips 100
Index calculation frequency Real Time
Source wwwbseindiacom
2952 Base Year
The financial year 1983-84 has been chosen as the base year The price stability
during that year and proximity to the index series were the main consideration for
choice of 1983-84 as the base year The base value was fixed at 100 points
2953 Dollex-100
BSE also calculates a dollar-linked version of SENSEX and historical values of this
index are available since its inception
2954 BSE-100 index - Scrip Selection Criteria
The general guidelines for selection of constituents in BSE-100 are as follows
Trading Frequency The scrip should have been traded on 95 of the trading days
54
in the last three months Exceptions can be made for extreme reasons like scrip
suspension etc
Final Rank The scrip should figure in the top 200 companies listed by final rank
The final rank is arrived at by assigning 75 weighted to the rank on the basis of
three-month average full market capitalization and 25 weighted to the liquidity rank
based on three-month average daily turnover amp three-month average impact cost
IndustrySector Representation Scrip selection would generally take into account a
balanced sectorial representation of the listed companies in the universe of BSE
Track Record In the opinion of the BSE Index Committee the company should
have an acceptable track record
210 STOCK MARKET VOLATILITY
2101 Meaning
Volatility is a measure for variation of price of a financial instrument over time
Historic volatility is derived from time series of past market prices An implied
volatility is derived from the market price of a market traded derivative (in particular
an option) Volatility does not measure the direction of price changes merely their
dispersion This is because when calculating standard deviation (or variance) all
differences are squared so that negative and positive differences are combined into
one quantity Two instruments with different volatilities may have the same expected
return but the instrument with higher volatility will have larger swings in values over
a given period of time
For example a lower volatility stock may have an expected (average) return of 7
with annual volatility of 5 This would indicate returns from approximately negative
3 to positive 17 most of the time (19 times out of 20 or 95 via a two standard
deviation rule) A higher volatility stock with the same expected return of 7 but
with annual volatility of 20 would indicate returns from approximately negative
33 to positive 47 most of the time (19 times out of 20 or 95) These estimates
assume a normal distribution in reality stocks are found to be leptokurtotic
55
2102 Terminology used in volatility
Volatility as described here refers to the actual current volatility of a financial
instrument for a specified period (for example 30 days or 90 days) It is the volatility
of a financial instrument based on historical prices over the specified period with the
last observation the most recent price This phrase is used particularly when it is
wished to distinguish between the actual current volatility of an instrument and
actual historical volatility which refers to the volatility of a financial instrument
over a specified period but with the last observation on a date in the past
actual future volatility which refers to the volatility of a financial instrument
over a specified period starting at the current time and ending at a future date
(normally the expiry date of an options)
historical implied volatility which refers to the implied volatility observed from
historical prices of the financial instrument (normally options)
current implied volatility which refers to the implied volatility observed from
current prices of the financial instrument
future implied volatility which refers to the implied volatility observed from
future prices of the financial instrument
For a financial instrument whose price follows a random walk or wiener process the
width of the distribution increases as time increases This is because there is an
increasing profitability that the instruments price will be farther away from the initial
price as time increases However rather than increase linearly the volatility increases
with the square-root of time as time increases because some fluctuations are expected
to cancel each other out so the most likely deviation after twice the time will not be
twice the distance from zero
2103 Usefulness of volatility for Investors
Investors care about volatility for five reasons
1 The wider the swings in an investments price the harder emotionally it is to
not worry
2 Price volatility of a trading instrument can define position sizing in a portfolio
56
3 When certain cash flows from selling a security are needed at a specific future
date higher volatility means a greater chance of a shortfall
4 Higher volatility of returns while saving for retirement results in a wider
distribution of possible final portfolio values
5 Higher volatility of return when retired gives withdrawals a larger permanent
impact on the portfolios value
6 Price volatility presents opportunities to buy assets cheaply and sell when
overpriced
31
The Calcutta Stock Exchange (CSE) was the largest stock exchange in India till the
1960s In 1961 there were 1203 listed companies across the various stock exchanges
of the country Of these 576 were listed on the CSE and 297 on the BSE However
during the later half of the 1960s the relative importance of the CSE declined while
that of the BSE increased sharply
One of the oldest stock markets in Asia the Indian Stock Markets have a 200 years
old history
Table 22 Origin of Indian Stock Market
Year Events
18th
Century
East India Company was the dominant institution and by end of the century business in its loan
securities gained full momentum
1830s Business on corporate stocks and shares in Bank and Cotton presses started in Bombay Trading list
by the end of 1839 got broader
1840s Recognition from banks and merchants to about half a dozen brokers
1850s Rapid development of commercial enterprise saw brokerage business attracting more people into
the business
1860s The number of brokers increased to 60
1860-61 The American Civil War broke out which caused a stoppage of cotton supply from United States of
America marking the beginning of the Share Mania in India
1862-63 The number of brokers increased to about 200 to 250
1865 A disastrous slump began at the end of the American Civil War (as an example Bank of Bombay
Share which had touched Rs 2850 could only be sold at Rs 87)
1874 With the rapidly developing share trading business brokers used to gather at a street (now well
known as Dalal Street) for the purpose of transacting business
1875 The Native Share and Stock Brokers Association (also known as The Bombay Stock
Exchange) was established in Bombay
1880s Development of cotton mills industry and set up of many others
1894 Establishment of The Ahmadabad Share and Stock Brokers Association
1880 -
90s
Sharp increase in share prices of jute industries in 1870s was followed by a boom in tea stocks and
coal
1908 The Calcutta Stock Exchange Association was formed
1920 Madras witnessed boom and business at The Madras Stock Exchange was transacted with 100
brokers
1923 When recession followed number of brokers came down to 3 and the Exchange was closed down
32
1934 Establishment of the Lahore Stock Exchange
1936 Merger of the Lahore Stock Exchange with the Punjab Stock Exchange
1937 Re-organization and set up of the Madras Stock Exchange Limited (Pvt) Limited led by
improvement in stock market activities in South India with establishment of new textile mills and
plantation companies
1940 Uttar Pradesh Stock Exchange Limited and Nagpur Stock Exchange Limited was established
1944 Establishment of The Hyderabad Stock Exchange Limited
1947 Delhi Stock and Share Brokers Association Limited and The Delhi Stocks and Shares Exchange
Limited were established and later on merged into The Delhi Stock Exchange Association
Limited
Sources wwwsurfindiacom wwwappuonlinecom
271 Post Independence Scenario
The depression witnessed after the Independence led to closure of a lot of exchanges
in the country Lahore Stock Exchange was closed down after the partition of India
and later on merged with the Delhi Stock Exchange Bangalore Stock Exchange
Limited was registered in 1957 and got recognition only by 1963 Most of the other
Exchanges were in a miserable state till 1957 when they applied for recognition under
Securities Contracts (Regulations) Act 1956 The Exchanges that were recognized
under the Act were
Bombay Calcutta Madras Ahmadabad Delhi Hyderabad Bangalore Indore
272 Many more stock exchanges were established during 1980s
namely
Cochin Stock Exchange (1980)
Uttar Pradesh Stock Exchange Association Limited (at Kanpur 1982)
Pune Stock Exchange Limited (1982)
Ludhiana Stock Exchange Association Limited (1983)
Gauhati Stock Exchange Limited (1984)
Kanara Stock Exchange Limited (at Mangalore 1985)
33
Magadh Stock Exchange Association (at Patna 1986)
Jaipur Stock Exchange Limited (1989)
Bhubaneswar Stock Exchange Association Limited (1989)
Saurashtra Kutch Stock Exchange Limited (at Rajkot 1989)
Vadodara Stock Exchange Limited (at Baroda 1990)
Coimbatore Stock Exchange
Meerut Stock Exchange
At present there are twenty one recognized stock exchanges in India which does not
include the Over The Counter Exchange of India Limited (OTCEI) and the National
Stock Exchange of India Limited (NSEIL)
Government policies during 1980s also played a vital role in the development of the
Indian Stock Markets There was a sharp increase in number of Exchanges listed
companies as well as their capital which is visible from the following table
Table 23 Pattern of Growth of Stock Exchanges
Source SEBI annual report
273 Trading Pattern of the Indian Stock Market
Indian Stock Exchanges allow trading of securities of only those public limited
companies that are listed on the Exchange(s) They are divided into two categories
S
No
As on 31st December 1946 1961 1971 1980 1991 1995 2000 2005
1 No of Stock Exchanges 7 7 8 9 20 22 23 23
2 No of Listed Cos 1125 1203 1599 2265 6229 8593 9413 4731
5 Market value of Capital
of Listed Cos (Cr Rs)
971 1292 2675 6750 110279 478121 6319212 478121
34
Chart 25 Trading Pattern of the Indian Stock Market
Source wwwbseindiacom
274 Types of Transactions
The flowchart below describes the types of transactions that can be carried out on the
Indian stock exchanges
Chart 26 Types of Transactions
Source wwwbseindiacom
Listed Securities of Public limited companies
Specified securities (forward List)
Equity shares of company that are
- Dividend paying
- growth orinted companies
- paid up capital of atleast Rs50 million
- Market capitalisation of atleast Rs100 million
- has more than 20000 shareholders
Non specicied Securities (Cash List)
equity shares of companies not covered in specified securities
Transactions on Indian Stock Exchanges
Spot Delivery Transactions
Forward Transactions
35
Spot Delivery Transactions
Includes transactions that require delivery and payment within stipulated time
period at the time of entering into the contract
This period shall not be more than 14 days following the date of the contract
Forward Transactions
Transactions in which delivery and payment can be extended by further period
of 14 days each
The overall period should not exceed 90 days from the date of contract
Transactions permitted only in case of specified shares
275 Indian stock exchange allows a member broker to perform
following activities
Act as an agent
Buy and sell securities for clients and charge commission for the same
Act as a trader or dealer as a principal
Buy and sell securities on their account and risk
276 Over The Counter Exchange of India (OTCEI)
Traditionally trading in Stock Exchanges in India followed a conventional style
where people used to gather at the Exchange and bids and offers were made by open
outcry This age-old trading mechanism in the Indian stock markets used to create
much functional inefficiency Lack of liquidity and transparency long settlement
periods and benami transactions are a few examples that adversely affected investors
In order to overcome these inefficiencies OTCEI was incorporated in 1990 under the
Companies Act 1956 OTCEI is the first screen based nationwide stock exchange in
India created by Unit Trust of India Industrial Credit and Investment Corporation of
India Industrial Development Bank of India SBI Capital Markets Industrial Finance
Corporation of India General Insurance Corporation and its subsidiaries and Can
Bank Financial Services
36
Chart 27 Securities traded on the OTCEI
Source wwwbseindiacom
Listed Securities
Securities of the companies listed on the OTC
Can be bought or sold at any OTC counter across India
Should not be listed anywhere else
Permitted Securities
Certain securities (Shares and debentures listed on other exchanges)
Unites of Mutual funds can be traded
Initiated Debentures
An equity holding a minimum of one lakh debentures of a particular scrip can
offer them for trading on the OTC
Advantages of OTCEI
Greater liquidity and lesser risk of intermediary charges due to widely spread trading
mechanism across India The screen-based scrip less trading ensures transparency and
accuracy of prices Faster settlement and transfer process as compared to other
exchanges Shorter allotment procedure (in case of a new issue) than other exchanges
277 National Stock Exchange
In order to lift the Indian stock market trading system at par with the international
standards On the basis of the recommendations of high powered Pherwani
Securities teaded on the
OTCEI
Listed Securities
Permitted Securities
Initiated Debentures
37
Committee the National Stock Exchange was incorporated in 1992 by Industrial
Development Bank of India Industrial Credit and Investment Corporation of India
Industrial Finance Corporation of India all Insurance Corporations selected
commercial banks and others
2771 NSE provides exposure to investors in two types of markets
namely
Wholesale debt market
Capital market
Wholesale Debt Market - Similar to money market operations debt market
operations involve institutional investors and corporate bodies entering into
transactions of high value in financial instruments like treasury bills government
securities commercial papers etc
Capital market- A capital market is a market for securities (debt or equity) where
business enterprises and governments can raise long term funds It is defined as a
market in which money is defined as a market in which money is provided for periods
longer than a year34 as the raising of short term funds takes place on other markets
Capital markets may be classified as primary markets and secondary markets In
primary markets new stock or bond issues are sold to investors via a mechanism
known as underwriting In the secondary markets existing securities are sold and
bought among investors or traders usually on a securities exchange over the counter
or elsewhere
278 Trading at NSE amp BSE
Fully automated screen-based trading mechanism
Strictly follows the principle of an order-driven market
Trading members are linked through a communication network
34 Steven M Sheffrin (2003) Economics Principles in action Upper Saddle River Pearson Prentice
Hall
38
This network allows them to execute trade from their offices
The prices at which the buyer and seller are willing to transact will appear on
the screen
When the prices match the transaction will be completed
A confirmation slip will be printed at the office of the trading member
2781 Advantages of trading at NSE amp BSE
Integrated network for trading in stock market of India
Fully automated screen based system that provides higher degree of
transparency
Investors can transact from any part of the country at uniform prices
Greater functional efficiency supported by totally computerized network
28 THE BOMBAY STOCK EXCHANGE
Formerly the Stock Exchange Mumbai popularly called Bombay Stock Exchange
or BSE is the oldest stock exchange in Asia and has the greatest number of listed
companies in the world with 4700 listed as of August 2007 35
It is located at Dalal Street Mumbai India On 31 December 2007 the equity market
capitalization of the BSE was US $ 179 trillion making it the largest stock exchange
in South Asia and the 12th largest in the world
With over 4700 Indian companies list on the stock exchange [10]
and it has a
significant trading volume The BSE SENSEX (SENSITIVE INDEX) also called the
―BSE 30 is a widely used market index in India and Asia Though many other
exchanges exist BSE and the National Stock Exchange of India account for most of
the trading in shares in India
35 World Federation of Exchanges (2007) wwwworld-exchangesorg
39
281 History of the Bombay Stock exchange
Trading in securities has been in vogue in India for a little over 200 years Trading in
securities dates back 1793 most of them being transactions in loan securities of the
East India Company The broking community prospered as there was a rise in prices
which led to a share mania during 1861-65 This bubble burst in 1865 when the
American Civil War ended The brokers realized that investor confidence in the
securities market could be sustained only by organizing themselves into a regulated
body with defined rules and regulations The realization resulted in formation of ―The
Native Share and Stock Brokerslsquo Association which later came to be known as the
Bombay Stock Exchange In 1875 these brokers assembled at a place now called
Dalal Street
The Bombay Stock Exchange is a voluntary nonprofit making association of broker
members It emerged as a premier stock exchange after the 1960 The increased pace
of industrialization caused by the two world wars protection to the domestic industry
and the governmentlsquos fiscal policies aided the growth of new issues which in turn
helped the BSE to prosper The BSE dominated the Indian Capital Market by
accounting for more than 60 per cent of the all Indian turn over
Until 1992 the BSE operated like a closed club of selected members With the
securities scam outburst in 1992 and the SEBI taking over the rains of the Stock
Market the BSE had to bring about changes in its operational policies Until March
1995 the BSE had an open outcry system of trading However when faced with stiff
competition from NSE the countrylsquos first modern computerized and professionally
managed stock exchange set up in 1994 the BSE had to change its system of trading
and operation
On 14 March 1995 the BSE turned to electronic trading whereby brokers trade using
computers This system is known as the BSE On-line Trading System (BOLT)
The introduction of BOLT helped in improving trading volumes significantly
reducing the spread between buy and sell orders better trading in odd lot shares fixed
income instruments and dealings in the renunciation of rights shares
40
In 1995 BOLT was limited to Mumbai whereas the NSE was operating at the
national level As a result the BSE submitted a proposal for allowing installation of
terminals connected to BOLT in centers outside Mumbai After rejecting the proposal
four times on 29 october 1996 the SEBI finally allowed the BSE to use its BOLT
system nationwide Later the BSE set up a central depository system to dematerialize
shares and promote demate Account (trading)
282 Hours of Operation
Beginning of the Day Session 800 to 900
Trading Session 900 to 1530
Position Transfer Session 1530 to 1550
Closing Session 1550 to 1605
Option Exercise Session 1605 to 1635
Margin Session 1635 to 1650
Query Session 1650 to1735
End of Day Session 1735
The hours of operation for the BSE quoted above are stated in terms of the local time
(ie GMT+530) in Mumbai India
BSElsquos normal trading sessions are on all days of the week except Saturdays Sundays
and Holidays declared by the Exchange in advance 36
283 Services of BSE
BSE also had a wide range of services to empower investors and facilitate smooth
transactions These services are as follows
2831 Investor Services
The Dept of investor services redresses grievances of investors BSE was the first
exchange in the country to provide an amount of Rs 1 million towards the investor
36 Asia Technical Analysis with Phil Smith wwwreutersindianet
41
protection fund it is an amount higher than that of any exchange in the country BSE
launched a nationwide investor awareness program ―Safe Investing in the Stock
Market under which 264 programmers were held in more than 200 cities
2832 The BSE Online Trading (BOLT)
BSE on line Trading (BOLT) facilities on-line screen based trading in securities
BOLT is currently operating in 25000 trader work stations located across over 399
cities in India
2833 BSEWEBXcom
In February 2001 BSE introduced the worldlsquos first centralized exchange based
Internet trading system BSEWEBXcom This initiative enables investors anywhere
in the world to trade on BSE platform
2834 Surveillance
BSElsquos Online Surveillance System (BOSS) monitors on a real time basis the price
movements volume position and real time measurements of the default risk market
reconstruct and generation of cross market alerts
2835 BSE Training Institute
BTI imparts capital market training and certification in collaboration with reputed
management institutes and universities It offers over 40 courses on various aspects of
the capital mark and financial sector More than 20000 people have attended the BTI
program
284 Awards
Fowling awards were given to BSE
The world council of Corporate Governance has awarded the Golden Peacock
Global CSR Award for BSElsquos initiatives in corporate social responsibility
The Annual Reports and Accounts of BSE for the year ended March 312006 and
42
March 312007 have been awarded the ICAI awards for excellence in financial
reporting
The Human Resource Management at BSE has won the Asia-Pacific HRM awards
for its efforts in employer branding through talent management at work health
management at work and excellence in HR through technology
Drawing from its rich past and its equally robust performance in the recent times
BSE will continue to remain an icon in the Indian Capital Market
285 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 days closing price is taken for computation of Index closure
The use of Index Closure Algorithm prevents any intentional manipulation of the
closing index value
286 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 affect the
index values The BSE Index Cell does the day-to-day maintenance of the index
within the broad index policy framework set by the BSE Index Committee The BSE
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 BSE Index Committee comprises
of capital market expert fund managers market participants and members of the BSE
Governing Board
43
287 On-Line Computation of the Index
During trading hours value of the Index is calculated and disseminated on real time
basis This is done automatically on the basis of prices at which trades in Index
constituents are executed
288 Adjustment for Bonus Rights and Newly Issued Capital
SENSEX calculation needs to be adjusted for issue of Bonus or 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 BSE Index Cell the base value is adjusted which is used to alter
market capitalization of the component stocks to arrive at the SENSEX value The
BSE Index Cell keeps a close watch on the events that might affect the index on a
regular basis and carries out daily maintenance of all the 19 Indices
2881 Adjustments for Rights Issues
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 (ex-right) price An offsetting or
proportionate adjustment is then made to the Base Market capitalization
2882 Adjustments for Bonus Issue
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
2883 Other Issues 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
buy-back of shares corporate restructuring etc
44
289 Listing Categories
Before badla was resumed in 1996 there were only two categories of securities listed
on the BSE the specified group of shares comprising The securities in which carry
forward deals were allowed and the cash group shares in which no carry forward deals
were permitted Later it was observed that the facility of carry forward was not being
used in all the 94 scrips in the specified group Hence after badla was resumed the
size of the specified group was reduced to 32 scrips on 3 April 1996 The BSE later
decided to regroup the existing A and B group shares into three categories The BSE
delisted 637 companies for a period of 3 years during 2004-05 for non-compliance of
listing agreements
A Group This group consists of large stock with turnover and high floating stock
with large market capitalization In other words scrips with more liquidity and high
networth are included in this group At present there are 150 scrips in this group
B1 Group This group includes scrips of quality companies with equity above Rs 3
crore with high growth potential and trading frequency No carry forward facility was
allowed in this group in June 2000 there were 1803 scrips in this group
B2 Group Scrips in this group were just like those of B1 but with fortnightly
settlement However in September 1996 the BSE introduced weekly settlement for all
scrips listed on the exchange thus doing away with the distinction between the B1 and
B2 groups On June 2000 there were 3219 scrips in this group
Z Group Subsequently a Z group was introduced in 1999 with scrips of companies
that do not meet the rules regulations and stipulations laid down by the exchange It
is a buyer beware company These are some 300 scrips in the group All Z category
stocks result in delivers
F Group A new Flsquo group pertaining to debt market segment was started with effect
from 9 September 1996
S Group The BSE reduced post-public issue capital base requirement from Rs10
crore to Rs3 crore to attract listing by companies with a smaller capital base It also
45
started a new trading segment small cap stock segment known as the Slsquo segment
Corporate with minimum turnover of an equal amount would be eligible to list scrips
on this segment In addition stocks listed on the regional exchanges would also be
able to list on the lsquoSlsquo segment subject to meeting certain criteria
2810 Base Market capitalization Adjustment
The formula for adjusting the Base Market capitalization is as follows
New Base Market Capitalization (NBMC)
New Market capitalization
NBMC = Old Base Market capitalization x mdashmdashmdashmdashmdashmdashmdashmdashmdashmdashmdash
Old Market capitalization
To illustrate suppose a company issues right shares which increases the market
capitalization of the shares of that company by say Rs100 crores The existing Base
Market capitalization (Old Base Market capitalization) say is Rs2450 crores and the
aggregate market capitalization of all the shares included in the index before the right
issue is made is say Rs4781 crore The New Base Market capitalization will then
be
2450x (4781+100)
_____________________ = Rs250124 crores
4781
This figure of Rs 250124 crore will be used as the Base Market capitalization for
calculating the index number from then onwards till the next base change becomes
necessary
Index Review Frequency
The BSE 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
29 STOCK MARKET INDEX
The stock market index is the most important indices of all as it measures overall
market sentiment through a set of stocks that representative of the market The stock
46
market index is a barometer of the market behavior It reflects direction and indicates
day-to-day fluctuations in stock prices The market index reflects expectations about
the behavior of the economy as a whole It is a precursor of economic cycles The
function of a stock index is to provide investors with information regarding the
average share price in the market An ideal index must represent changes in the prices
of the scrips and reflect price movements of typical shares for better market
representation Stock index is a barometer of a nationlsquos economic health as market
prices reflect expectations about the economylsquos performance Stock indices termed as
leading economic as they indicate what is going to happen in the economy in the
future The returns generated in the stock market are based on future expectations A
good market index incorporates a set of scrips which have high market capitalization
and high liquidity Market capitalization is the sum of the market value of all the
stocks included in the index The market value is derived by multiplying the price of
the share outstanding In other words the bid-ask spread is minimum The index on a
day is calculated as the percentage of the aggregate market value of the set of scrips
incorporated in the index on that day to the average market value of the same scrips
during the base period
291 Definition of an Index
A price index is such as the stock market price of the individual securities in the
market It reflects the overall price or return movements of a group of securities
Movements in an index are determined by sample weighting and computational
procedure Sample is normally generated by random selection or try a non random
selection technique designed to incorporate desired characteristics are used to select
sample shares rather than by completely random selection Major criteria for selection
are market activity due representation to various industrial groups and to major stock
exchanges
292 Global Stock Market Indices
2921 The Dow Jones Industrial averagersquos
It is the most widely watched and quoted index because of its long existence The
Dow has 30 constituents and it follows the methodology of price based weighted
47
Changes to stocks included in the Dow are infrequent three stocks were
addeddropped in 1991 four in 1997 and four in 1999 The addition of Microsoft and
Intel in 1999 was the first inclusion of Nasdaq market stocks to the Dow 30
2922 The Nasdaq composite index
The index is the market capitalization weighted of prices for all the stocks listed in the
Nasdaq stock market The Nasdaq composite began on 8 February 1971 with a base
of 100
2923 The Nasdaq 100 index
Nasdaq 100 comprises the largest computer software and telecom stocks by market
capitalization on the Nasdaq For a company to be included in the Nasdaq 100 it must
have a minimum average trading volume of 100000 shares per day and must have
been trading on a major exchange for at least a year or two
2924 The S amp P 500 index
This index comprises 500 biggest publicly traded companies in the US by market
capitalization Most money managers treat the S amp P 500 as a proxy for the US stock
market The S amp P 500 tries to cover all major areas of US economy To be included a
company must be profitable the prospective company must not be closely hold and
must have a large trading volume for its shares
2925 The FTSE 100
The FTSE 100 consists of the largest 100 companies by full market Value listed on
the London Stock Exchange The FTSE 100 is the benchmark index to indicate the
performance of the European market It is a market capitalization weighted index that
also considers the free float weighted of individual stocks before including them in
the index
2926 The MSCI Indices
Include the MSCIEAFE (Europe Australia and Far East) MSCI Europe MSCI
world MSCI (EMF) and MSCI Pacific Basin Indices
48
The MSCI world Index is a free float adjusted market capitalization index that is
designed to measure global developed market equity performance As of April 2002
the MSCI world Index consisted of the MSCI world Index consisted of the following
23 developed market country indices
Australia Austria Belgium Canada Denmark Finland France Germany Greece
Hong Kong Ireland Italy Japan Netherlands New Zealand Norway Singapore
Portugal Spain Sweden Switzerland United Kingdom and the United States of
America
293 Methodology for Calculating The Index
2931 Price Weighted Index
In this method the price of each stock in the index is summed up which is then
equated to an index starting value An arbitrary date is set as the base and the
Laspeyerlsquos Price Index which measures price changes against a fixed base period
quantity weight is used In case of a stock split the market price of the stock falls and
these results in less weighted in the index The Dow Jones Industrial Average and
Nikkie 225 are price-weighted indices
2932 Equal Weighting
In this method each stocklsquos percentage weight in the index is equal and hence all
stocks have an equal influence on the index movement The value line index at
Kansas City Board of Trade (KCBT) is an equal weighted index
2933 Market Capitalization Weighted
29331 Full Market Capitalization Method
In this method the number of shares outstanding multiplied by the market price of a
companylsquos share determines the scriplsquos weighted in the index The shares with the
highest market capitalization would have a higher weighted and would be most
influential in this type of index Eg S amp P 500 Index in USA and S amp P CNX Nify in
India
49
29332 Modified Capitalization Weighted
This method seeks to limit the influence of the largest stocks in the index which
otherwise would dominate the entire index This method sets a limit on the largest
stock or a group of stocks The NASDAQ 100 Index is calculated by using this
method
294 Free Float Market Capitalization Method
2941 Concept
Free float methodology refers to an index construction methodology that takes in to
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 Strategic holding government 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
All BSE indices with exception of BSE-PSU index have adopted the free-float
methodology
2942 Definition of Free Float
Share holding of investor that would not in the normal course come into the
open market for trading are treated as ―Controlling Strategic Holding and
hence not included in free float specifically the following categories of
holding are generally excluded from the definition of free float
Shares hold by foundersdirectorsacquires which has control element
Shares held by person with ―Controlling Interestlsquo
Shares held by Govt as promoters
50
Holding through the FDI Route
Strategic Stakes by private corporate bodiesindividuals
Equity held by employee welfare trusts
Locked-in-shares and shares which not be sold in the open market in normal
course
2943 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-agrave-Vis an investible
index This enables an apple-to-apple comparison thereby facilitating better
evaluation of performance of active managers
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 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
The free float methodology of index construction is considered to be an industry best
practice and all major index providers like MSCI FTSE SampP 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
51
29441 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 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 055 means that only 55 of the market
capitalization of the company will be considered for index calculation
Table 24 Free-float Bands
Free-Float Free-Float Factor Free-Float Free-Float Factor
gt0 - 5 005 gt50 - 55 055
gt5 - 10 010 gt55 - 60 060
gt10 - 15 015 gt60 - 65 065
gt15 - 20 020 gt65 - 70 070
gt20 - 25 025 gt70 - 75 075
gt25 - 30 030 gt75 - 80 080
gt30 - 35 035 gt80 - 85 085
gt35 - 40 040 gt85 - 90 090
gt40 - 45 045 gt90 - 95 095
gt45 - 50 050 gt95 - 100 100
Source wwwbseindiacom
295 BSE Indices
For the premier stock exchange that pioneered the securities transaction business
in India over a century of experience is a proud achievement A lot has changed since
1875 when 318 persons by paying a then princely amount of Re 1 became members
of what today is called Bombay Stock Exchange Limited (BSE) Over the decades
the stock market in the country has passed through good and bad periods The journey
52
in the 20th century has not been an easy one Till the decade of eighties there was no
measure or scale that could precisely measure the various ups and downs in the Indian
stock market BSE in 1986 came out with a Stock Index-SENSEX- that subsequently
became the barometer of the Indian stock market
The launch of SENSEX in 1986 was later followed up in January 1989 by
introduction of BSE National Index (Base 1983-84 = 100) It comprised 100 stocks
listed at five major stock exchanges in India - Mumbai Calcutta Delhi Ahmadabad
and Madras The BSE National Index was renamed BSE-100 Index from October 14
1996 and since then it is being calculated taking into consideration only the prices of
stocks listed at BSE BSE launched the dollar-linked version of BSE-100 index on
May 22 2006
With a view to provide a better representation of the increasing number of listed
companies larger market capitalization and the new industry sectors BSE launched
on 27th May 1994 two new index series viz the BSE-200 and the DOLLEX-200
Since then BSE has come a long way in attuning itself to the varied needs of
investors and market participants In order to fulfill the need for still broader
segment-specific and sector-specific indices BSE has continuously been increasing
the range of its indices BSE-500 Index and 5 sectorial indices were launched in 1999
In 2001 BSE launched BSE-PSU Index DOLLEX-30 and the countrys first free-
float based index - the BSE TEC Index Over the years BSE shifted all its indices to
the free-float methodology
BSE disseminates information on the Price-Earnings Ratio the Price to Book Value
Ratio and the Dividend Yield Percentage on day-to-day basis of all its major indices
The values of all BSE indices are updated on real time basis during market hours and
displayed through the BOLT system BSE website and news wire agencies
All BSE Indices are reviewed periodically by the BSE Index Committee This
Committee which comprises eminent independent finance professionals frames the
broad policy guidelines for the development and maintenance of all BSE indices The
BSE Index Cell carries out the day-to-day maintenance of all indices and conducts
research on development of new indices
53
2951 BSE-100 Index
A broad-based index the BSE-100 was formerly known as the BSE National index
This Index has 1983-84 as the base year and was launched in 1989 In line with the
shift of the BSE Indices to the globally accepted Free-Float methodology BSE-100
was shifted to Free-Float methodology effective from April 5 2004 The method of
computation of Free-Float index and determination of free-float factors is similar to
the methodology for SENSEX
Table 25 Index Specification
Base Year 1983-84
Base Index Value 100
Date of Launch 3-Jan-89
Method of calculation Launched on full market capitalization
method and effective April 05 2004
calculation method shifted to free-float
market capitalization
Number of scrips 100
Index calculation frequency Real Time
Source wwwbseindiacom
2952 Base Year
The financial year 1983-84 has been chosen as the base year The price stability
during that year and proximity to the index series were the main consideration for
choice of 1983-84 as the base year The base value was fixed at 100 points
2953 Dollex-100
BSE also calculates a dollar-linked version of SENSEX and historical values of this
index are available since its inception
2954 BSE-100 index - Scrip Selection Criteria
The general guidelines for selection of constituents in BSE-100 are as follows
Trading Frequency The scrip should have been traded on 95 of the trading days
54
in the last three months Exceptions can be made for extreme reasons like scrip
suspension etc
Final Rank The scrip should figure in the top 200 companies listed by final rank
The final rank is arrived at by assigning 75 weighted to the rank on the basis of
three-month average full market capitalization and 25 weighted to the liquidity rank
based on three-month average daily turnover amp three-month average impact cost
IndustrySector Representation Scrip selection would generally take into account a
balanced sectorial representation of the listed companies in the universe of BSE
Track Record In the opinion of the BSE Index Committee the company should
have an acceptable track record
210 STOCK MARKET VOLATILITY
2101 Meaning
Volatility is a measure for variation of price of a financial instrument over time
Historic volatility is derived from time series of past market prices An implied
volatility is derived from the market price of a market traded derivative (in particular
an option) Volatility does not measure the direction of price changes merely their
dispersion This is because when calculating standard deviation (or variance) all
differences are squared so that negative and positive differences are combined into
one quantity Two instruments with different volatilities may have the same expected
return but the instrument with higher volatility will have larger swings in values over
a given period of time
For example a lower volatility stock may have an expected (average) return of 7
with annual volatility of 5 This would indicate returns from approximately negative
3 to positive 17 most of the time (19 times out of 20 or 95 via a two standard
deviation rule) A higher volatility stock with the same expected return of 7 but
with annual volatility of 20 would indicate returns from approximately negative
33 to positive 47 most of the time (19 times out of 20 or 95) These estimates
assume a normal distribution in reality stocks are found to be leptokurtotic
55
2102 Terminology used in volatility
Volatility as described here refers to the actual current volatility of a financial
instrument for a specified period (for example 30 days or 90 days) It is the volatility
of a financial instrument based on historical prices over the specified period with the
last observation the most recent price This phrase is used particularly when it is
wished to distinguish between the actual current volatility of an instrument and
actual historical volatility which refers to the volatility of a financial instrument
over a specified period but with the last observation on a date in the past
actual future volatility which refers to the volatility of a financial instrument
over a specified period starting at the current time and ending at a future date
(normally the expiry date of an options)
historical implied volatility which refers to the implied volatility observed from
historical prices of the financial instrument (normally options)
current implied volatility which refers to the implied volatility observed from
current prices of the financial instrument
future implied volatility which refers to the implied volatility observed from
future prices of the financial instrument
For a financial instrument whose price follows a random walk or wiener process the
width of the distribution increases as time increases This is because there is an
increasing profitability that the instruments price will be farther away from the initial
price as time increases However rather than increase linearly the volatility increases
with the square-root of time as time increases because some fluctuations are expected
to cancel each other out so the most likely deviation after twice the time will not be
twice the distance from zero
2103 Usefulness of volatility for Investors
Investors care about volatility for five reasons
1 The wider the swings in an investments price the harder emotionally it is to
not worry
2 Price volatility of a trading instrument can define position sizing in a portfolio
56
3 When certain cash flows from selling a security are needed at a specific future
date higher volatility means a greater chance of a shortfall
4 Higher volatility of returns while saving for retirement results in a wider
distribution of possible final portfolio values
5 Higher volatility of return when retired gives withdrawals a larger permanent
impact on the portfolios value
6 Price volatility presents opportunities to buy assets cheaply and sell when
overpriced
32
1934 Establishment of the Lahore Stock Exchange
1936 Merger of the Lahore Stock Exchange with the Punjab Stock Exchange
1937 Re-organization and set up of the Madras Stock Exchange Limited (Pvt) Limited led by
improvement in stock market activities in South India with establishment of new textile mills and
plantation companies
1940 Uttar Pradesh Stock Exchange Limited and Nagpur Stock Exchange Limited was established
1944 Establishment of The Hyderabad Stock Exchange Limited
1947 Delhi Stock and Share Brokers Association Limited and The Delhi Stocks and Shares Exchange
Limited were established and later on merged into The Delhi Stock Exchange Association
Limited
Sources wwwsurfindiacom wwwappuonlinecom
271 Post Independence Scenario
The depression witnessed after the Independence led to closure of a lot of exchanges
in the country Lahore Stock Exchange was closed down after the partition of India
and later on merged with the Delhi Stock Exchange Bangalore Stock Exchange
Limited was registered in 1957 and got recognition only by 1963 Most of the other
Exchanges were in a miserable state till 1957 when they applied for recognition under
Securities Contracts (Regulations) Act 1956 The Exchanges that were recognized
under the Act were
Bombay Calcutta Madras Ahmadabad Delhi Hyderabad Bangalore Indore
272 Many more stock exchanges were established during 1980s
namely
Cochin Stock Exchange (1980)
Uttar Pradesh Stock Exchange Association Limited (at Kanpur 1982)
Pune Stock Exchange Limited (1982)
Ludhiana Stock Exchange Association Limited (1983)
Gauhati Stock Exchange Limited (1984)
Kanara Stock Exchange Limited (at Mangalore 1985)
33
Magadh Stock Exchange Association (at Patna 1986)
Jaipur Stock Exchange Limited (1989)
Bhubaneswar Stock Exchange Association Limited (1989)
Saurashtra Kutch Stock Exchange Limited (at Rajkot 1989)
Vadodara Stock Exchange Limited (at Baroda 1990)
Coimbatore Stock Exchange
Meerut Stock Exchange
At present there are twenty one recognized stock exchanges in India which does not
include the Over The Counter Exchange of India Limited (OTCEI) and the National
Stock Exchange of India Limited (NSEIL)
Government policies during 1980s also played a vital role in the development of the
Indian Stock Markets There was a sharp increase in number of Exchanges listed
companies as well as their capital which is visible from the following table
Table 23 Pattern of Growth of Stock Exchanges
Source SEBI annual report
273 Trading Pattern of the Indian Stock Market
Indian Stock Exchanges allow trading of securities of only those public limited
companies that are listed on the Exchange(s) They are divided into two categories
S
No
As on 31st December 1946 1961 1971 1980 1991 1995 2000 2005
1 No of Stock Exchanges 7 7 8 9 20 22 23 23
2 No of Listed Cos 1125 1203 1599 2265 6229 8593 9413 4731
5 Market value of Capital
of Listed Cos (Cr Rs)
971 1292 2675 6750 110279 478121 6319212 478121
34
Chart 25 Trading Pattern of the Indian Stock Market
Source wwwbseindiacom
274 Types of Transactions
The flowchart below describes the types of transactions that can be carried out on the
Indian stock exchanges
Chart 26 Types of Transactions
Source wwwbseindiacom
Listed Securities of Public limited companies
Specified securities (forward List)
Equity shares of company that are
- Dividend paying
- growth orinted companies
- paid up capital of atleast Rs50 million
- Market capitalisation of atleast Rs100 million
- has more than 20000 shareholders
Non specicied Securities (Cash List)
equity shares of companies not covered in specified securities
Transactions on Indian Stock Exchanges
Spot Delivery Transactions
Forward Transactions
35
Spot Delivery Transactions
Includes transactions that require delivery and payment within stipulated time
period at the time of entering into the contract
This period shall not be more than 14 days following the date of the contract
Forward Transactions
Transactions in which delivery and payment can be extended by further period
of 14 days each
The overall period should not exceed 90 days from the date of contract
Transactions permitted only in case of specified shares
275 Indian stock exchange allows a member broker to perform
following activities
Act as an agent
Buy and sell securities for clients and charge commission for the same
Act as a trader or dealer as a principal
Buy and sell securities on their account and risk
276 Over The Counter Exchange of India (OTCEI)
Traditionally trading in Stock Exchanges in India followed a conventional style
where people used to gather at the Exchange and bids and offers were made by open
outcry This age-old trading mechanism in the Indian stock markets used to create
much functional inefficiency Lack of liquidity and transparency long settlement
periods and benami transactions are a few examples that adversely affected investors
In order to overcome these inefficiencies OTCEI was incorporated in 1990 under the
Companies Act 1956 OTCEI is the first screen based nationwide stock exchange in
India created by Unit Trust of India Industrial Credit and Investment Corporation of
India Industrial Development Bank of India SBI Capital Markets Industrial Finance
Corporation of India General Insurance Corporation and its subsidiaries and Can
Bank Financial Services
36
Chart 27 Securities traded on the OTCEI
Source wwwbseindiacom
Listed Securities
Securities of the companies listed on the OTC
Can be bought or sold at any OTC counter across India
Should not be listed anywhere else
Permitted Securities
Certain securities (Shares and debentures listed on other exchanges)
Unites of Mutual funds can be traded
Initiated Debentures
An equity holding a minimum of one lakh debentures of a particular scrip can
offer them for trading on the OTC
Advantages of OTCEI
Greater liquidity and lesser risk of intermediary charges due to widely spread trading
mechanism across India The screen-based scrip less trading ensures transparency and
accuracy of prices Faster settlement and transfer process as compared to other
exchanges Shorter allotment procedure (in case of a new issue) than other exchanges
277 National Stock Exchange
In order to lift the Indian stock market trading system at par with the international
standards On the basis of the recommendations of high powered Pherwani
Securities teaded on the
OTCEI
Listed Securities
Permitted Securities
Initiated Debentures
37
Committee the National Stock Exchange was incorporated in 1992 by Industrial
Development Bank of India Industrial Credit and Investment Corporation of India
Industrial Finance Corporation of India all Insurance Corporations selected
commercial banks and others
2771 NSE provides exposure to investors in two types of markets
namely
Wholesale debt market
Capital market
Wholesale Debt Market - Similar to money market operations debt market
operations involve institutional investors and corporate bodies entering into
transactions of high value in financial instruments like treasury bills government
securities commercial papers etc
Capital market- A capital market is a market for securities (debt or equity) where
business enterprises and governments can raise long term funds It is defined as a
market in which money is defined as a market in which money is provided for periods
longer than a year34 as the raising of short term funds takes place on other markets
Capital markets may be classified as primary markets and secondary markets In
primary markets new stock or bond issues are sold to investors via a mechanism
known as underwriting In the secondary markets existing securities are sold and
bought among investors or traders usually on a securities exchange over the counter
or elsewhere
278 Trading at NSE amp BSE
Fully automated screen-based trading mechanism
Strictly follows the principle of an order-driven market
Trading members are linked through a communication network
34 Steven M Sheffrin (2003) Economics Principles in action Upper Saddle River Pearson Prentice
Hall
38
This network allows them to execute trade from their offices
The prices at which the buyer and seller are willing to transact will appear on
the screen
When the prices match the transaction will be completed
A confirmation slip will be printed at the office of the trading member
2781 Advantages of trading at NSE amp BSE
Integrated network for trading in stock market of India
Fully automated screen based system that provides higher degree of
transparency
Investors can transact from any part of the country at uniform prices
Greater functional efficiency supported by totally computerized network
28 THE BOMBAY STOCK EXCHANGE
Formerly the Stock Exchange Mumbai popularly called Bombay Stock Exchange
or BSE is the oldest stock exchange in Asia and has the greatest number of listed
companies in the world with 4700 listed as of August 2007 35
It is located at Dalal Street Mumbai India On 31 December 2007 the equity market
capitalization of the BSE was US $ 179 trillion making it the largest stock exchange
in South Asia and the 12th largest in the world
With over 4700 Indian companies list on the stock exchange [10]
and it has a
significant trading volume The BSE SENSEX (SENSITIVE INDEX) also called the
―BSE 30 is a widely used market index in India and Asia Though many other
exchanges exist BSE and the National Stock Exchange of India account for most of
the trading in shares in India
35 World Federation of Exchanges (2007) wwwworld-exchangesorg
39
281 History of the Bombay Stock exchange
Trading in securities has been in vogue in India for a little over 200 years Trading in
securities dates back 1793 most of them being transactions in loan securities of the
East India Company The broking community prospered as there was a rise in prices
which led to a share mania during 1861-65 This bubble burst in 1865 when the
American Civil War ended The brokers realized that investor confidence in the
securities market could be sustained only by organizing themselves into a regulated
body with defined rules and regulations The realization resulted in formation of ―The
Native Share and Stock Brokerslsquo Association which later came to be known as the
Bombay Stock Exchange In 1875 these brokers assembled at a place now called
Dalal Street
The Bombay Stock Exchange is a voluntary nonprofit making association of broker
members It emerged as a premier stock exchange after the 1960 The increased pace
of industrialization caused by the two world wars protection to the domestic industry
and the governmentlsquos fiscal policies aided the growth of new issues which in turn
helped the BSE to prosper The BSE dominated the Indian Capital Market by
accounting for more than 60 per cent of the all Indian turn over
Until 1992 the BSE operated like a closed club of selected members With the
securities scam outburst in 1992 and the SEBI taking over the rains of the Stock
Market the BSE had to bring about changes in its operational policies Until March
1995 the BSE had an open outcry system of trading However when faced with stiff
competition from NSE the countrylsquos first modern computerized and professionally
managed stock exchange set up in 1994 the BSE had to change its system of trading
and operation
On 14 March 1995 the BSE turned to electronic trading whereby brokers trade using
computers This system is known as the BSE On-line Trading System (BOLT)
The introduction of BOLT helped in improving trading volumes significantly
reducing the spread between buy and sell orders better trading in odd lot shares fixed
income instruments and dealings in the renunciation of rights shares
40
In 1995 BOLT was limited to Mumbai whereas the NSE was operating at the
national level As a result the BSE submitted a proposal for allowing installation of
terminals connected to BOLT in centers outside Mumbai After rejecting the proposal
four times on 29 october 1996 the SEBI finally allowed the BSE to use its BOLT
system nationwide Later the BSE set up a central depository system to dematerialize
shares and promote demate Account (trading)
282 Hours of Operation
Beginning of the Day Session 800 to 900
Trading Session 900 to 1530
Position Transfer Session 1530 to 1550
Closing Session 1550 to 1605
Option Exercise Session 1605 to 1635
Margin Session 1635 to 1650
Query Session 1650 to1735
End of Day Session 1735
The hours of operation for the BSE quoted above are stated in terms of the local time
(ie GMT+530) in Mumbai India
BSElsquos normal trading sessions are on all days of the week except Saturdays Sundays
and Holidays declared by the Exchange in advance 36
283 Services of BSE
BSE also had a wide range of services to empower investors and facilitate smooth
transactions These services are as follows
2831 Investor Services
The Dept of investor services redresses grievances of investors BSE was the first
exchange in the country to provide an amount of Rs 1 million towards the investor
36 Asia Technical Analysis with Phil Smith wwwreutersindianet
41
protection fund it is an amount higher than that of any exchange in the country BSE
launched a nationwide investor awareness program ―Safe Investing in the Stock
Market under which 264 programmers were held in more than 200 cities
2832 The BSE Online Trading (BOLT)
BSE on line Trading (BOLT) facilities on-line screen based trading in securities
BOLT is currently operating in 25000 trader work stations located across over 399
cities in India
2833 BSEWEBXcom
In February 2001 BSE introduced the worldlsquos first centralized exchange based
Internet trading system BSEWEBXcom This initiative enables investors anywhere
in the world to trade on BSE platform
2834 Surveillance
BSElsquos Online Surveillance System (BOSS) monitors on a real time basis the price
movements volume position and real time measurements of the default risk market
reconstruct and generation of cross market alerts
2835 BSE Training Institute
BTI imparts capital market training and certification in collaboration with reputed
management institutes and universities It offers over 40 courses on various aspects of
the capital mark and financial sector More than 20000 people have attended the BTI
program
284 Awards
Fowling awards were given to BSE
The world council of Corporate Governance has awarded the Golden Peacock
Global CSR Award for BSElsquos initiatives in corporate social responsibility
The Annual Reports and Accounts of BSE for the year ended March 312006 and
42
March 312007 have been awarded the ICAI awards for excellence in financial
reporting
The Human Resource Management at BSE has won the Asia-Pacific HRM awards
for its efforts in employer branding through talent management at work health
management at work and excellence in HR through technology
Drawing from its rich past and its equally robust performance in the recent times
BSE will continue to remain an icon in the Indian Capital Market
285 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 days closing price is taken for computation of Index closure
The use of Index Closure Algorithm prevents any intentional manipulation of the
closing index value
286 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 affect the
index values The BSE Index Cell does the day-to-day maintenance of the index
within the broad index policy framework set by the BSE Index Committee The BSE
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 BSE Index Committee comprises
of capital market expert fund managers market participants and members of the BSE
Governing Board
43
287 On-Line Computation of the Index
During trading hours value of the Index is calculated and disseminated on real time
basis This is done automatically on the basis of prices at which trades in Index
constituents are executed
288 Adjustment for Bonus Rights and Newly Issued Capital
SENSEX calculation needs to be adjusted for issue of Bonus or 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 BSE Index Cell the base value is adjusted which is used to alter
market capitalization of the component stocks to arrive at the SENSEX value The
BSE Index Cell keeps a close watch on the events that might affect the index on a
regular basis and carries out daily maintenance of all the 19 Indices
2881 Adjustments for Rights Issues
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 (ex-right) price An offsetting or
proportionate adjustment is then made to the Base Market capitalization
2882 Adjustments for Bonus Issue
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
2883 Other Issues 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
buy-back of shares corporate restructuring etc
44
289 Listing Categories
Before badla was resumed in 1996 there were only two categories of securities listed
on the BSE the specified group of shares comprising The securities in which carry
forward deals were allowed and the cash group shares in which no carry forward deals
were permitted Later it was observed that the facility of carry forward was not being
used in all the 94 scrips in the specified group Hence after badla was resumed the
size of the specified group was reduced to 32 scrips on 3 April 1996 The BSE later
decided to regroup the existing A and B group shares into three categories The BSE
delisted 637 companies for a period of 3 years during 2004-05 for non-compliance of
listing agreements
A Group This group consists of large stock with turnover and high floating stock
with large market capitalization In other words scrips with more liquidity and high
networth are included in this group At present there are 150 scrips in this group
B1 Group This group includes scrips of quality companies with equity above Rs 3
crore with high growth potential and trading frequency No carry forward facility was
allowed in this group in June 2000 there were 1803 scrips in this group
B2 Group Scrips in this group were just like those of B1 but with fortnightly
settlement However in September 1996 the BSE introduced weekly settlement for all
scrips listed on the exchange thus doing away with the distinction between the B1 and
B2 groups On June 2000 there were 3219 scrips in this group
Z Group Subsequently a Z group was introduced in 1999 with scrips of companies
that do not meet the rules regulations and stipulations laid down by the exchange It
is a buyer beware company These are some 300 scrips in the group All Z category
stocks result in delivers
F Group A new Flsquo group pertaining to debt market segment was started with effect
from 9 September 1996
S Group The BSE reduced post-public issue capital base requirement from Rs10
crore to Rs3 crore to attract listing by companies with a smaller capital base It also
45
started a new trading segment small cap stock segment known as the Slsquo segment
Corporate with minimum turnover of an equal amount would be eligible to list scrips
on this segment In addition stocks listed on the regional exchanges would also be
able to list on the lsquoSlsquo segment subject to meeting certain criteria
2810 Base Market capitalization Adjustment
The formula for adjusting the Base Market capitalization is as follows
New Base Market Capitalization (NBMC)
New Market capitalization
NBMC = Old Base Market capitalization x mdashmdashmdashmdashmdashmdashmdashmdashmdashmdashmdash
Old Market capitalization
To illustrate suppose a company issues right shares which increases the market
capitalization of the shares of that company by say Rs100 crores The existing Base
Market capitalization (Old Base Market capitalization) say is Rs2450 crores and the
aggregate market capitalization of all the shares included in the index before the right
issue is made is say Rs4781 crore The New Base Market capitalization will then
be
2450x (4781+100)
_____________________ = Rs250124 crores
4781
This figure of Rs 250124 crore will be used as the Base Market capitalization for
calculating the index number from then onwards till the next base change becomes
necessary
Index Review Frequency
The BSE 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
29 STOCK MARKET INDEX
The stock market index is the most important indices of all as it measures overall
market sentiment through a set of stocks that representative of the market The stock
46
market index is a barometer of the market behavior It reflects direction and indicates
day-to-day fluctuations in stock prices The market index reflects expectations about
the behavior of the economy as a whole It is a precursor of economic cycles The
function of a stock index is to provide investors with information regarding the
average share price in the market An ideal index must represent changes in the prices
of the scrips and reflect price movements of typical shares for better market
representation Stock index is a barometer of a nationlsquos economic health as market
prices reflect expectations about the economylsquos performance Stock indices termed as
leading economic as they indicate what is going to happen in the economy in the
future The returns generated in the stock market are based on future expectations A
good market index incorporates a set of scrips which have high market capitalization
and high liquidity Market capitalization is the sum of the market value of all the
stocks included in the index The market value is derived by multiplying the price of
the share outstanding In other words the bid-ask spread is minimum The index on a
day is calculated as the percentage of the aggregate market value of the set of scrips
incorporated in the index on that day to the average market value of the same scrips
during the base period
291 Definition of an Index
A price index is such as the stock market price of the individual securities in the
market It reflects the overall price or return movements of a group of securities
Movements in an index are determined by sample weighting and computational
procedure Sample is normally generated by random selection or try a non random
selection technique designed to incorporate desired characteristics are used to select
sample shares rather than by completely random selection Major criteria for selection
are market activity due representation to various industrial groups and to major stock
exchanges
292 Global Stock Market Indices
2921 The Dow Jones Industrial averagersquos
It is the most widely watched and quoted index because of its long existence The
Dow has 30 constituents and it follows the methodology of price based weighted
47
Changes to stocks included in the Dow are infrequent three stocks were
addeddropped in 1991 four in 1997 and four in 1999 The addition of Microsoft and
Intel in 1999 was the first inclusion of Nasdaq market stocks to the Dow 30
2922 The Nasdaq composite index
The index is the market capitalization weighted of prices for all the stocks listed in the
Nasdaq stock market The Nasdaq composite began on 8 February 1971 with a base
of 100
2923 The Nasdaq 100 index
Nasdaq 100 comprises the largest computer software and telecom stocks by market
capitalization on the Nasdaq For a company to be included in the Nasdaq 100 it must
have a minimum average trading volume of 100000 shares per day and must have
been trading on a major exchange for at least a year or two
2924 The S amp P 500 index
This index comprises 500 biggest publicly traded companies in the US by market
capitalization Most money managers treat the S amp P 500 as a proxy for the US stock
market The S amp P 500 tries to cover all major areas of US economy To be included a
company must be profitable the prospective company must not be closely hold and
must have a large trading volume for its shares
2925 The FTSE 100
The FTSE 100 consists of the largest 100 companies by full market Value listed on
the London Stock Exchange The FTSE 100 is the benchmark index to indicate the
performance of the European market It is a market capitalization weighted index that
also considers the free float weighted of individual stocks before including them in
the index
2926 The MSCI Indices
Include the MSCIEAFE (Europe Australia and Far East) MSCI Europe MSCI
world MSCI (EMF) and MSCI Pacific Basin Indices
48
The MSCI world Index is a free float adjusted market capitalization index that is
designed to measure global developed market equity performance As of April 2002
the MSCI world Index consisted of the MSCI world Index consisted of the following
23 developed market country indices
Australia Austria Belgium Canada Denmark Finland France Germany Greece
Hong Kong Ireland Italy Japan Netherlands New Zealand Norway Singapore
Portugal Spain Sweden Switzerland United Kingdom and the United States of
America
293 Methodology for Calculating The Index
2931 Price Weighted Index
In this method the price of each stock in the index is summed up which is then
equated to an index starting value An arbitrary date is set as the base and the
Laspeyerlsquos Price Index which measures price changes against a fixed base period
quantity weight is used In case of a stock split the market price of the stock falls and
these results in less weighted in the index The Dow Jones Industrial Average and
Nikkie 225 are price-weighted indices
2932 Equal Weighting
In this method each stocklsquos percentage weight in the index is equal and hence all
stocks have an equal influence on the index movement The value line index at
Kansas City Board of Trade (KCBT) is an equal weighted index
2933 Market Capitalization Weighted
29331 Full Market Capitalization Method
In this method the number of shares outstanding multiplied by the market price of a
companylsquos share determines the scriplsquos weighted in the index The shares with the
highest market capitalization would have a higher weighted and would be most
influential in this type of index Eg S amp P 500 Index in USA and S amp P CNX Nify in
India
49
29332 Modified Capitalization Weighted
This method seeks to limit the influence of the largest stocks in the index which
otherwise would dominate the entire index This method sets a limit on the largest
stock or a group of stocks The NASDAQ 100 Index is calculated by using this
method
294 Free Float Market Capitalization Method
2941 Concept
Free float methodology refers to an index construction methodology that takes in to
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 Strategic holding government 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
All BSE indices with exception of BSE-PSU index have adopted the free-float
methodology
2942 Definition of Free Float
Share holding of investor that would not in the normal course come into the
open market for trading are treated as ―Controlling Strategic Holding and
hence not included in free float specifically the following categories of
holding are generally excluded from the definition of free float
Shares hold by foundersdirectorsacquires which has control element
Shares held by person with ―Controlling Interestlsquo
Shares held by Govt as promoters
50
Holding through the FDI Route
Strategic Stakes by private corporate bodiesindividuals
Equity held by employee welfare trusts
Locked-in-shares and shares which not be sold in the open market in normal
course
2943 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-agrave-Vis an investible
index This enables an apple-to-apple comparison thereby facilitating better
evaluation of performance of active managers
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 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
The free float methodology of index construction is considered to be an industry best
practice and all major index providers like MSCI FTSE SampP 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
51
29441 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 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 055 means that only 55 of the market
capitalization of the company will be considered for index calculation
Table 24 Free-float Bands
Free-Float Free-Float Factor Free-Float Free-Float Factor
gt0 - 5 005 gt50 - 55 055
gt5 - 10 010 gt55 - 60 060
gt10 - 15 015 gt60 - 65 065
gt15 - 20 020 gt65 - 70 070
gt20 - 25 025 gt70 - 75 075
gt25 - 30 030 gt75 - 80 080
gt30 - 35 035 gt80 - 85 085
gt35 - 40 040 gt85 - 90 090
gt40 - 45 045 gt90 - 95 095
gt45 - 50 050 gt95 - 100 100
Source wwwbseindiacom
295 BSE Indices
For the premier stock exchange that pioneered the securities transaction business
in India over a century of experience is a proud achievement A lot has changed since
1875 when 318 persons by paying a then princely amount of Re 1 became members
of what today is called Bombay Stock Exchange Limited (BSE) Over the decades
the stock market in the country has passed through good and bad periods The journey
52
in the 20th century has not been an easy one Till the decade of eighties there was no
measure or scale that could precisely measure the various ups and downs in the Indian
stock market BSE in 1986 came out with a Stock Index-SENSEX- that subsequently
became the barometer of the Indian stock market
The launch of SENSEX in 1986 was later followed up in January 1989 by
introduction of BSE National Index (Base 1983-84 = 100) It comprised 100 stocks
listed at five major stock exchanges in India - Mumbai Calcutta Delhi Ahmadabad
and Madras The BSE National Index was renamed BSE-100 Index from October 14
1996 and since then it is being calculated taking into consideration only the prices of
stocks listed at BSE BSE launched the dollar-linked version of BSE-100 index on
May 22 2006
With a view to provide a better representation of the increasing number of listed
companies larger market capitalization and the new industry sectors BSE launched
on 27th May 1994 two new index series viz the BSE-200 and the DOLLEX-200
Since then BSE has come a long way in attuning itself to the varied needs of
investors and market participants In order to fulfill the need for still broader
segment-specific and sector-specific indices BSE has continuously been increasing
the range of its indices BSE-500 Index and 5 sectorial indices were launched in 1999
In 2001 BSE launched BSE-PSU Index DOLLEX-30 and the countrys first free-
float based index - the BSE TEC Index Over the years BSE shifted all its indices to
the free-float methodology
BSE disseminates information on the Price-Earnings Ratio the Price to Book Value
Ratio and the Dividend Yield Percentage on day-to-day basis of all its major indices
The values of all BSE indices are updated on real time basis during market hours and
displayed through the BOLT system BSE website and news wire agencies
All BSE Indices are reviewed periodically by the BSE Index Committee This
Committee which comprises eminent independent finance professionals frames the
broad policy guidelines for the development and maintenance of all BSE indices The
BSE Index Cell carries out the day-to-day maintenance of all indices and conducts
research on development of new indices
53
2951 BSE-100 Index
A broad-based index the BSE-100 was formerly known as the BSE National index
This Index has 1983-84 as the base year and was launched in 1989 In line with the
shift of the BSE Indices to the globally accepted Free-Float methodology BSE-100
was shifted to Free-Float methodology effective from April 5 2004 The method of
computation of Free-Float index and determination of free-float factors is similar to
the methodology for SENSEX
Table 25 Index Specification
Base Year 1983-84
Base Index Value 100
Date of Launch 3-Jan-89
Method of calculation Launched on full market capitalization
method and effective April 05 2004
calculation method shifted to free-float
market capitalization
Number of scrips 100
Index calculation frequency Real Time
Source wwwbseindiacom
2952 Base Year
The financial year 1983-84 has been chosen as the base year The price stability
during that year and proximity to the index series were the main consideration for
choice of 1983-84 as the base year The base value was fixed at 100 points
2953 Dollex-100
BSE also calculates a dollar-linked version of SENSEX and historical values of this
index are available since its inception
2954 BSE-100 index - Scrip Selection Criteria
The general guidelines for selection of constituents in BSE-100 are as follows
Trading Frequency The scrip should have been traded on 95 of the trading days
54
in the last three months Exceptions can be made for extreme reasons like scrip
suspension etc
Final Rank The scrip should figure in the top 200 companies listed by final rank
The final rank is arrived at by assigning 75 weighted to the rank on the basis of
three-month average full market capitalization and 25 weighted to the liquidity rank
based on three-month average daily turnover amp three-month average impact cost
IndustrySector Representation Scrip selection would generally take into account a
balanced sectorial representation of the listed companies in the universe of BSE
Track Record In the opinion of the BSE Index Committee the company should
have an acceptable track record
210 STOCK MARKET VOLATILITY
2101 Meaning
Volatility is a measure for variation of price of a financial instrument over time
Historic volatility is derived from time series of past market prices An implied
volatility is derived from the market price of a market traded derivative (in particular
an option) Volatility does not measure the direction of price changes merely their
dispersion This is because when calculating standard deviation (or variance) all
differences are squared so that negative and positive differences are combined into
one quantity Two instruments with different volatilities may have the same expected
return but the instrument with higher volatility will have larger swings in values over
a given period of time
For example a lower volatility stock may have an expected (average) return of 7
with annual volatility of 5 This would indicate returns from approximately negative
3 to positive 17 most of the time (19 times out of 20 or 95 via a two standard
deviation rule) A higher volatility stock with the same expected return of 7 but
with annual volatility of 20 would indicate returns from approximately negative
33 to positive 47 most of the time (19 times out of 20 or 95) These estimates
assume a normal distribution in reality stocks are found to be leptokurtotic
55
2102 Terminology used in volatility
Volatility as described here refers to the actual current volatility of a financial
instrument for a specified period (for example 30 days or 90 days) It is the volatility
of a financial instrument based on historical prices over the specified period with the
last observation the most recent price This phrase is used particularly when it is
wished to distinguish between the actual current volatility of an instrument and
actual historical volatility which refers to the volatility of a financial instrument
over a specified period but with the last observation on a date in the past
actual future volatility which refers to the volatility of a financial instrument
over a specified period starting at the current time and ending at a future date
(normally the expiry date of an options)
historical implied volatility which refers to the implied volatility observed from
historical prices of the financial instrument (normally options)
current implied volatility which refers to the implied volatility observed from
current prices of the financial instrument
future implied volatility which refers to the implied volatility observed from
future prices of the financial instrument
For a financial instrument whose price follows a random walk or wiener process the
width of the distribution increases as time increases This is because there is an
increasing profitability that the instruments price will be farther away from the initial
price as time increases However rather than increase linearly the volatility increases
with the square-root of time as time increases because some fluctuations are expected
to cancel each other out so the most likely deviation after twice the time will not be
twice the distance from zero
2103 Usefulness of volatility for Investors
Investors care about volatility for five reasons
1 The wider the swings in an investments price the harder emotionally it is to
not worry
2 Price volatility of a trading instrument can define position sizing in a portfolio
56
3 When certain cash flows from selling a security are needed at a specific future
date higher volatility means a greater chance of a shortfall
4 Higher volatility of returns while saving for retirement results in a wider
distribution of possible final portfolio values
5 Higher volatility of return when retired gives withdrawals a larger permanent
impact on the portfolios value
6 Price volatility presents opportunities to buy assets cheaply and sell when
overpriced
33
Magadh Stock Exchange Association (at Patna 1986)
Jaipur Stock Exchange Limited (1989)
Bhubaneswar Stock Exchange Association Limited (1989)
Saurashtra Kutch Stock Exchange Limited (at Rajkot 1989)
Vadodara Stock Exchange Limited (at Baroda 1990)
Coimbatore Stock Exchange
Meerut Stock Exchange
At present there are twenty one recognized stock exchanges in India which does not
include the Over The Counter Exchange of India Limited (OTCEI) and the National
Stock Exchange of India Limited (NSEIL)
Government policies during 1980s also played a vital role in the development of the
Indian Stock Markets There was a sharp increase in number of Exchanges listed
companies as well as their capital which is visible from the following table
Table 23 Pattern of Growth of Stock Exchanges
Source SEBI annual report
273 Trading Pattern of the Indian Stock Market
Indian Stock Exchanges allow trading of securities of only those public limited
companies that are listed on the Exchange(s) They are divided into two categories
S
No
As on 31st December 1946 1961 1971 1980 1991 1995 2000 2005
1 No of Stock Exchanges 7 7 8 9 20 22 23 23
2 No of Listed Cos 1125 1203 1599 2265 6229 8593 9413 4731
5 Market value of Capital
of Listed Cos (Cr Rs)
971 1292 2675 6750 110279 478121 6319212 478121
34
Chart 25 Trading Pattern of the Indian Stock Market
Source wwwbseindiacom
274 Types of Transactions
The flowchart below describes the types of transactions that can be carried out on the
Indian stock exchanges
Chart 26 Types of Transactions
Source wwwbseindiacom
Listed Securities of Public limited companies
Specified securities (forward List)
Equity shares of company that are
- Dividend paying
- growth orinted companies
- paid up capital of atleast Rs50 million
- Market capitalisation of atleast Rs100 million
- has more than 20000 shareholders
Non specicied Securities (Cash List)
equity shares of companies not covered in specified securities
Transactions on Indian Stock Exchanges
Spot Delivery Transactions
Forward Transactions
35
Spot Delivery Transactions
Includes transactions that require delivery and payment within stipulated time
period at the time of entering into the contract
This period shall not be more than 14 days following the date of the contract
Forward Transactions
Transactions in which delivery and payment can be extended by further period
of 14 days each
The overall period should not exceed 90 days from the date of contract
Transactions permitted only in case of specified shares
275 Indian stock exchange allows a member broker to perform
following activities
Act as an agent
Buy and sell securities for clients and charge commission for the same
Act as a trader or dealer as a principal
Buy and sell securities on their account and risk
276 Over The Counter Exchange of India (OTCEI)
Traditionally trading in Stock Exchanges in India followed a conventional style
where people used to gather at the Exchange and bids and offers were made by open
outcry This age-old trading mechanism in the Indian stock markets used to create
much functional inefficiency Lack of liquidity and transparency long settlement
periods and benami transactions are a few examples that adversely affected investors
In order to overcome these inefficiencies OTCEI was incorporated in 1990 under the
Companies Act 1956 OTCEI is the first screen based nationwide stock exchange in
India created by Unit Trust of India Industrial Credit and Investment Corporation of
India Industrial Development Bank of India SBI Capital Markets Industrial Finance
Corporation of India General Insurance Corporation and its subsidiaries and Can
Bank Financial Services
36
Chart 27 Securities traded on the OTCEI
Source wwwbseindiacom
Listed Securities
Securities of the companies listed on the OTC
Can be bought or sold at any OTC counter across India
Should not be listed anywhere else
Permitted Securities
Certain securities (Shares and debentures listed on other exchanges)
Unites of Mutual funds can be traded
Initiated Debentures
An equity holding a minimum of one lakh debentures of a particular scrip can
offer them for trading on the OTC
Advantages of OTCEI
Greater liquidity and lesser risk of intermediary charges due to widely spread trading
mechanism across India The screen-based scrip less trading ensures transparency and
accuracy of prices Faster settlement and transfer process as compared to other
exchanges Shorter allotment procedure (in case of a new issue) than other exchanges
277 National Stock Exchange
In order to lift the Indian stock market trading system at par with the international
standards On the basis of the recommendations of high powered Pherwani
Securities teaded on the
OTCEI
Listed Securities
Permitted Securities
Initiated Debentures
37
Committee the National Stock Exchange was incorporated in 1992 by Industrial
Development Bank of India Industrial Credit and Investment Corporation of India
Industrial Finance Corporation of India all Insurance Corporations selected
commercial banks and others
2771 NSE provides exposure to investors in two types of markets
namely
Wholesale debt market
Capital market
Wholesale Debt Market - Similar to money market operations debt market
operations involve institutional investors and corporate bodies entering into
transactions of high value in financial instruments like treasury bills government
securities commercial papers etc
Capital market- A capital market is a market for securities (debt or equity) where
business enterprises and governments can raise long term funds It is defined as a
market in which money is defined as a market in which money is provided for periods
longer than a year34 as the raising of short term funds takes place on other markets
Capital markets may be classified as primary markets and secondary markets In
primary markets new stock or bond issues are sold to investors via a mechanism
known as underwriting In the secondary markets existing securities are sold and
bought among investors or traders usually on a securities exchange over the counter
or elsewhere
278 Trading at NSE amp BSE
Fully automated screen-based trading mechanism
Strictly follows the principle of an order-driven market
Trading members are linked through a communication network
34 Steven M Sheffrin (2003) Economics Principles in action Upper Saddle River Pearson Prentice
Hall
38
This network allows them to execute trade from their offices
The prices at which the buyer and seller are willing to transact will appear on
the screen
When the prices match the transaction will be completed
A confirmation slip will be printed at the office of the trading member
2781 Advantages of trading at NSE amp BSE
Integrated network for trading in stock market of India
Fully automated screen based system that provides higher degree of
transparency
Investors can transact from any part of the country at uniform prices
Greater functional efficiency supported by totally computerized network
28 THE BOMBAY STOCK EXCHANGE
Formerly the Stock Exchange Mumbai popularly called Bombay Stock Exchange
or BSE is the oldest stock exchange in Asia and has the greatest number of listed
companies in the world with 4700 listed as of August 2007 35
It is located at Dalal Street Mumbai India On 31 December 2007 the equity market
capitalization of the BSE was US $ 179 trillion making it the largest stock exchange
in South Asia and the 12th largest in the world
With over 4700 Indian companies list on the stock exchange [10]
and it has a
significant trading volume The BSE SENSEX (SENSITIVE INDEX) also called the
―BSE 30 is a widely used market index in India and Asia Though many other
exchanges exist BSE and the National Stock Exchange of India account for most of
the trading in shares in India
35 World Federation of Exchanges (2007) wwwworld-exchangesorg
39
281 History of the Bombay Stock exchange
Trading in securities has been in vogue in India for a little over 200 years Trading in
securities dates back 1793 most of them being transactions in loan securities of the
East India Company The broking community prospered as there was a rise in prices
which led to a share mania during 1861-65 This bubble burst in 1865 when the
American Civil War ended The brokers realized that investor confidence in the
securities market could be sustained only by organizing themselves into a regulated
body with defined rules and regulations The realization resulted in formation of ―The
Native Share and Stock Brokerslsquo Association which later came to be known as the
Bombay Stock Exchange In 1875 these brokers assembled at a place now called
Dalal Street
The Bombay Stock Exchange is a voluntary nonprofit making association of broker
members It emerged as a premier stock exchange after the 1960 The increased pace
of industrialization caused by the two world wars protection to the domestic industry
and the governmentlsquos fiscal policies aided the growth of new issues which in turn
helped the BSE to prosper The BSE dominated the Indian Capital Market by
accounting for more than 60 per cent of the all Indian turn over
Until 1992 the BSE operated like a closed club of selected members With the
securities scam outburst in 1992 and the SEBI taking over the rains of the Stock
Market the BSE had to bring about changes in its operational policies Until March
1995 the BSE had an open outcry system of trading However when faced with stiff
competition from NSE the countrylsquos first modern computerized and professionally
managed stock exchange set up in 1994 the BSE had to change its system of trading
and operation
On 14 March 1995 the BSE turned to electronic trading whereby brokers trade using
computers This system is known as the BSE On-line Trading System (BOLT)
The introduction of BOLT helped in improving trading volumes significantly
reducing the spread between buy and sell orders better trading in odd lot shares fixed
income instruments and dealings in the renunciation of rights shares
40
In 1995 BOLT was limited to Mumbai whereas the NSE was operating at the
national level As a result the BSE submitted a proposal for allowing installation of
terminals connected to BOLT in centers outside Mumbai After rejecting the proposal
four times on 29 october 1996 the SEBI finally allowed the BSE to use its BOLT
system nationwide Later the BSE set up a central depository system to dematerialize
shares and promote demate Account (trading)
282 Hours of Operation
Beginning of the Day Session 800 to 900
Trading Session 900 to 1530
Position Transfer Session 1530 to 1550
Closing Session 1550 to 1605
Option Exercise Session 1605 to 1635
Margin Session 1635 to 1650
Query Session 1650 to1735
End of Day Session 1735
The hours of operation for the BSE quoted above are stated in terms of the local time
(ie GMT+530) in Mumbai India
BSElsquos normal trading sessions are on all days of the week except Saturdays Sundays
and Holidays declared by the Exchange in advance 36
283 Services of BSE
BSE also had a wide range of services to empower investors and facilitate smooth
transactions These services are as follows
2831 Investor Services
The Dept of investor services redresses grievances of investors BSE was the first
exchange in the country to provide an amount of Rs 1 million towards the investor
36 Asia Technical Analysis with Phil Smith wwwreutersindianet
41
protection fund it is an amount higher than that of any exchange in the country BSE
launched a nationwide investor awareness program ―Safe Investing in the Stock
Market under which 264 programmers were held in more than 200 cities
2832 The BSE Online Trading (BOLT)
BSE on line Trading (BOLT) facilities on-line screen based trading in securities
BOLT is currently operating in 25000 trader work stations located across over 399
cities in India
2833 BSEWEBXcom
In February 2001 BSE introduced the worldlsquos first centralized exchange based
Internet trading system BSEWEBXcom This initiative enables investors anywhere
in the world to trade on BSE platform
2834 Surveillance
BSElsquos Online Surveillance System (BOSS) monitors on a real time basis the price
movements volume position and real time measurements of the default risk market
reconstruct and generation of cross market alerts
2835 BSE Training Institute
BTI imparts capital market training and certification in collaboration with reputed
management institutes and universities It offers over 40 courses on various aspects of
the capital mark and financial sector More than 20000 people have attended the BTI
program
284 Awards
Fowling awards were given to BSE
The world council of Corporate Governance has awarded the Golden Peacock
Global CSR Award for BSElsquos initiatives in corporate social responsibility
The Annual Reports and Accounts of BSE for the year ended March 312006 and
42
March 312007 have been awarded the ICAI awards for excellence in financial
reporting
The Human Resource Management at BSE has won the Asia-Pacific HRM awards
for its efforts in employer branding through talent management at work health
management at work and excellence in HR through technology
Drawing from its rich past and its equally robust performance in the recent times
BSE will continue to remain an icon in the Indian Capital Market
285 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 days closing price is taken for computation of Index closure
The use of Index Closure Algorithm prevents any intentional manipulation of the
closing index value
286 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 affect the
index values The BSE Index Cell does the day-to-day maintenance of the index
within the broad index policy framework set by the BSE Index Committee The BSE
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 BSE Index Committee comprises
of capital market expert fund managers market participants and members of the BSE
Governing Board
43
287 On-Line Computation of the Index
During trading hours value of the Index is calculated and disseminated on real time
basis This is done automatically on the basis of prices at which trades in Index
constituents are executed
288 Adjustment for Bonus Rights and Newly Issued Capital
SENSEX calculation needs to be adjusted for issue of Bonus or 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 BSE Index Cell the base value is adjusted which is used to alter
market capitalization of the component stocks to arrive at the SENSEX value The
BSE Index Cell keeps a close watch on the events that might affect the index on a
regular basis and carries out daily maintenance of all the 19 Indices
2881 Adjustments for Rights Issues
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 (ex-right) price An offsetting or
proportionate adjustment is then made to the Base Market capitalization
2882 Adjustments for Bonus Issue
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
2883 Other Issues 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
buy-back of shares corporate restructuring etc
44
289 Listing Categories
Before badla was resumed in 1996 there were only two categories of securities listed
on the BSE the specified group of shares comprising The securities in which carry
forward deals were allowed and the cash group shares in which no carry forward deals
were permitted Later it was observed that the facility of carry forward was not being
used in all the 94 scrips in the specified group Hence after badla was resumed the
size of the specified group was reduced to 32 scrips on 3 April 1996 The BSE later
decided to regroup the existing A and B group shares into three categories The BSE
delisted 637 companies for a period of 3 years during 2004-05 for non-compliance of
listing agreements
A Group This group consists of large stock with turnover and high floating stock
with large market capitalization In other words scrips with more liquidity and high
networth are included in this group At present there are 150 scrips in this group
B1 Group This group includes scrips of quality companies with equity above Rs 3
crore with high growth potential and trading frequency No carry forward facility was
allowed in this group in June 2000 there were 1803 scrips in this group
B2 Group Scrips in this group were just like those of B1 but with fortnightly
settlement However in September 1996 the BSE introduced weekly settlement for all
scrips listed on the exchange thus doing away with the distinction between the B1 and
B2 groups On June 2000 there were 3219 scrips in this group
Z Group Subsequently a Z group was introduced in 1999 with scrips of companies
that do not meet the rules regulations and stipulations laid down by the exchange It
is a buyer beware company These are some 300 scrips in the group All Z category
stocks result in delivers
F Group A new Flsquo group pertaining to debt market segment was started with effect
from 9 September 1996
S Group The BSE reduced post-public issue capital base requirement from Rs10
crore to Rs3 crore to attract listing by companies with a smaller capital base It also
45
started a new trading segment small cap stock segment known as the Slsquo segment
Corporate with minimum turnover of an equal amount would be eligible to list scrips
on this segment In addition stocks listed on the regional exchanges would also be
able to list on the lsquoSlsquo segment subject to meeting certain criteria
2810 Base Market capitalization Adjustment
The formula for adjusting the Base Market capitalization is as follows
New Base Market Capitalization (NBMC)
New Market capitalization
NBMC = Old Base Market capitalization x mdashmdashmdashmdashmdashmdashmdashmdashmdashmdashmdash
Old Market capitalization
To illustrate suppose a company issues right shares which increases the market
capitalization of the shares of that company by say Rs100 crores The existing Base
Market capitalization (Old Base Market capitalization) say is Rs2450 crores and the
aggregate market capitalization of all the shares included in the index before the right
issue is made is say Rs4781 crore The New Base Market capitalization will then
be
2450x (4781+100)
_____________________ = Rs250124 crores
4781
This figure of Rs 250124 crore will be used as the Base Market capitalization for
calculating the index number from then onwards till the next base change becomes
necessary
Index Review Frequency
The BSE 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
29 STOCK MARKET INDEX
The stock market index is the most important indices of all as it measures overall
market sentiment through a set of stocks that representative of the market The stock
46
market index is a barometer of the market behavior It reflects direction and indicates
day-to-day fluctuations in stock prices The market index reflects expectations about
the behavior of the economy as a whole It is a precursor of economic cycles The
function of a stock index is to provide investors with information regarding the
average share price in the market An ideal index must represent changes in the prices
of the scrips and reflect price movements of typical shares for better market
representation Stock index is a barometer of a nationlsquos economic health as market
prices reflect expectations about the economylsquos performance Stock indices termed as
leading economic as they indicate what is going to happen in the economy in the
future The returns generated in the stock market are based on future expectations A
good market index incorporates a set of scrips which have high market capitalization
and high liquidity Market capitalization is the sum of the market value of all the
stocks included in the index The market value is derived by multiplying the price of
the share outstanding In other words the bid-ask spread is minimum The index on a
day is calculated as the percentage of the aggregate market value of the set of scrips
incorporated in the index on that day to the average market value of the same scrips
during the base period
291 Definition of an Index
A price index is such as the stock market price of the individual securities in the
market It reflects the overall price or return movements of a group of securities
Movements in an index are determined by sample weighting and computational
procedure Sample is normally generated by random selection or try a non random
selection technique designed to incorporate desired characteristics are used to select
sample shares rather than by completely random selection Major criteria for selection
are market activity due representation to various industrial groups and to major stock
exchanges
292 Global Stock Market Indices
2921 The Dow Jones Industrial averagersquos
It is the most widely watched and quoted index because of its long existence The
Dow has 30 constituents and it follows the methodology of price based weighted
47
Changes to stocks included in the Dow are infrequent three stocks were
addeddropped in 1991 four in 1997 and four in 1999 The addition of Microsoft and
Intel in 1999 was the first inclusion of Nasdaq market stocks to the Dow 30
2922 The Nasdaq composite index
The index is the market capitalization weighted of prices for all the stocks listed in the
Nasdaq stock market The Nasdaq composite began on 8 February 1971 with a base
of 100
2923 The Nasdaq 100 index
Nasdaq 100 comprises the largest computer software and telecom stocks by market
capitalization on the Nasdaq For a company to be included in the Nasdaq 100 it must
have a minimum average trading volume of 100000 shares per day and must have
been trading on a major exchange for at least a year or two
2924 The S amp P 500 index
This index comprises 500 biggest publicly traded companies in the US by market
capitalization Most money managers treat the S amp P 500 as a proxy for the US stock
market The S amp P 500 tries to cover all major areas of US economy To be included a
company must be profitable the prospective company must not be closely hold and
must have a large trading volume for its shares
2925 The FTSE 100
The FTSE 100 consists of the largest 100 companies by full market Value listed on
the London Stock Exchange The FTSE 100 is the benchmark index to indicate the
performance of the European market It is a market capitalization weighted index that
also considers the free float weighted of individual stocks before including them in
the index
2926 The MSCI Indices
Include the MSCIEAFE (Europe Australia and Far East) MSCI Europe MSCI
world MSCI (EMF) and MSCI Pacific Basin Indices
48
The MSCI world Index is a free float adjusted market capitalization index that is
designed to measure global developed market equity performance As of April 2002
the MSCI world Index consisted of the MSCI world Index consisted of the following
23 developed market country indices
Australia Austria Belgium Canada Denmark Finland France Germany Greece
Hong Kong Ireland Italy Japan Netherlands New Zealand Norway Singapore
Portugal Spain Sweden Switzerland United Kingdom and the United States of
America
293 Methodology for Calculating The Index
2931 Price Weighted Index
In this method the price of each stock in the index is summed up which is then
equated to an index starting value An arbitrary date is set as the base and the
Laspeyerlsquos Price Index which measures price changes against a fixed base period
quantity weight is used In case of a stock split the market price of the stock falls and
these results in less weighted in the index The Dow Jones Industrial Average and
Nikkie 225 are price-weighted indices
2932 Equal Weighting
In this method each stocklsquos percentage weight in the index is equal and hence all
stocks have an equal influence on the index movement The value line index at
Kansas City Board of Trade (KCBT) is an equal weighted index
2933 Market Capitalization Weighted
29331 Full Market Capitalization Method
In this method the number of shares outstanding multiplied by the market price of a
companylsquos share determines the scriplsquos weighted in the index The shares with the
highest market capitalization would have a higher weighted and would be most
influential in this type of index Eg S amp P 500 Index in USA and S amp P CNX Nify in
India
49
29332 Modified Capitalization Weighted
This method seeks to limit the influence of the largest stocks in the index which
otherwise would dominate the entire index This method sets a limit on the largest
stock or a group of stocks The NASDAQ 100 Index is calculated by using this
method
294 Free Float Market Capitalization Method
2941 Concept
Free float methodology refers to an index construction methodology that takes in to
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 Strategic holding government 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
All BSE indices with exception of BSE-PSU index have adopted the free-float
methodology
2942 Definition of Free Float
Share holding of investor that would not in the normal course come into the
open market for trading are treated as ―Controlling Strategic Holding and
hence not included in free float specifically the following categories of
holding are generally excluded from the definition of free float
Shares hold by foundersdirectorsacquires which has control element
Shares held by person with ―Controlling Interestlsquo
Shares held by Govt as promoters
50
Holding through the FDI Route
Strategic Stakes by private corporate bodiesindividuals
Equity held by employee welfare trusts
Locked-in-shares and shares which not be sold in the open market in normal
course
2943 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-agrave-Vis an investible
index This enables an apple-to-apple comparison thereby facilitating better
evaluation of performance of active managers
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 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
The free float methodology of index construction is considered to be an industry best
practice and all major index providers like MSCI FTSE SampP 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
51
29441 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 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 055 means that only 55 of the market
capitalization of the company will be considered for index calculation
Table 24 Free-float Bands
Free-Float Free-Float Factor Free-Float Free-Float Factor
gt0 - 5 005 gt50 - 55 055
gt5 - 10 010 gt55 - 60 060
gt10 - 15 015 gt60 - 65 065
gt15 - 20 020 gt65 - 70 070
gt20 - 25 025 gt70 - 75 075
gt25 - 30 030 gt75 - 80 080
gt30 - 35 035 gt80 - 85 085
gt35 - 40 040 gt85 - 90 090
gt40 - 45 045 gt90 - 95 095
gt45 - 50 050 gt95 - 100 100
Source wwwbseindiacom
295 BSE Indices
For the premier stock exchange that pioneered the securities transaction business
in India over a century of experience is a proud achievement A lot has changed since
1875 when 318 persons by paying a then princely amount of Re 1 became members
of what today is called Bombay Stock Exchange Limited (BSE) Over the decades
the stock market in the country has passed through good and bad periods The journey
52
in the 20th century has not been an easy one Till the decade of eighties there was no
measure or scale that could precisely measure the various ups and downs in the Indian
stock market BSE in 1986 came out with a Stock Index-SENSEX- that subsequently
became the barometer of the Indian stock market
The launch of SENSEX in 1986 was later followed up in January 1989 by
introduction of BSE National Index (Base 1983-84 = 100) It comprised 100 stocks
listed at five major stock exchanges in India - Mumbai Calcutta Delhi Ahmadabad
and Madras The BSE National Index was renamed BSE-100 Index from October 14
1996 and since then it is being calculated taking into consideration only the prices of
stocks listed at BSE BSE launched the dollar-linked version of BSE-100 index on
May 22 2006
With a view to provide a better representation of the increasing number of listed
companies larger market capitalization and the new industry sectors BSE launched
on 27th May 1994 two new index series viz the BSE-200 and the DOLLEX-200
Since then BSE has come a long way in attuning itself to the varied needs of
investors and market participants In order to fulfill the need for still broader
segment-specific and sector-specific indices BSE has continuously been increasing
the range of its indices BSE-500 Index and 5 sectorial indices were launched in 1999
In 2001 BSE launched BSE-PSU Index DOLLEX-30 and the countrys first free-
float based index - the BSE TEC Index Over the years BSE shifted all its indices to
the free-float methodology
BSE disseminates information on the Price-Earnings Ratio the Price to Book Value
Ratio and the Dividend Yield Percentage on day-to-day basis of all its major indices
The values of all BSE indices are updated on real time basis during market hours and
displayed through the BOLT system BSE website and news wire agencies
All BSE Indices are reviewed periodically by the BSE Index Committee This
Committee which comprises eminent independent finance professionals frames the
broad policy guidelines for the development and maintenance of all BSE indices The
BSE Index Cell carries out the day-to-day maintenance of all indices and conducts
research on development of new indices
53
2951 BSE-100 Index
A broad-based index the BSE-100 was formerly known as the BSE National index
This Index has 1983-84 as the base year and was launched in 1989 In line with the
shift of the BSE Indices to the globally accepted Free-Float methodology BSE-100
was shifted to Free-Float methodology effective from April 5 2004 The method of
computation of Free-Float index and determination of free-float factors is similar to
the methodology for SENSEX
Table 25 Index Specification
Base Year 1983-84
Base Index Value 100
Date of Launch 3-Jan-89
Method of calculation Launched on full market capitalization
method and effective April 05 2004
calculation method shifted to free-float
market capitalization
Number of scrips 100
Index calculation frequency Real Time
Source wwwbseindiacom
2952 Base Year
The financial year 1983-84 has been chosen as the base year The price stability
during that year and proximity to the index series were the main consideration for
choice of 1983-84 as the base year The base value was fixed at 100 points
2953 Dollex-100
BSE also calculates a dollar-linked version of SENSEX and historical values of this
index are available since its inception
2954 BSE-100 index - Scrip Selection Criteria
The general guidelines for selection of constituents in BSE-100 are as follows
Trading Frequency The scrip should have been traded on 95 of the trading days
54
in the last three months Exceptions can be made for extreme reasons like scrip
suspension etc
Final Rank The scrip should figure in the top 200 companies listed by final rank
The final rank is arrived at by assigning 75 weighted to the rank on the basis of
three-month average full market capitalization and 25 weighted to the liquidity rank
based on three-month average daily turnover amp three-month average impact cost
IndustrySector Representation Scrip selection would generally take into account a
balanced sectorial representation of the listed companies in the universe of BSE
Track Record In the opinion of the BSE Index Committee the company should
have an acceptable track record
210 STOCK MARKET VOLATILITY
2101 Meaning
Volatility is a measure for variation of price of a financial instrument over time
Historic volatility is derived from time series of past market prices An implied
volatility is derived from the market price of a market traded derivative (in particular
an option) Volatility does not measure the direction of price changes merely their
dispersion This is because when calculating standard deviation (or variance) all
differences are squared so that negative and positive differences are combined into
one quantity Two instruments with different volatilities may have the same expected
return but the instrument with higher volatility will have larger swings in values over
a given period of time
For example a lower volatility stock may have an expected (average) return of 7
with annual volatility of 5 This would indicate returns from approximately negative
3 to positive 17 most of the time (19 times out of 20 or 95 via a two standard
deviation rule) A higher volatility stock with the same expected return of 7 but
with annual volatility of 20 would indicate returns from approximately negative
33 to positive 47 most of the time (19 times out of 20 or 95) These estimates
assume a normal distribution in reality stocks are found to be leptokurtotic
55
2102 Terminology used in volatility
Volatility as described here refers to the actual current volatility of a financial
instrument for a specified period (for example 30 days or 90 days) It is the volatility
of a financial instrument based on historical prices over the specified period with the
last observation the most recent price This phrase is used particularly when it is
wished to distinguish between the actual current volatility of an instrument and
actual historical volatility which refers to the volatility of a financial instrument
over a specified period but with the last observation on a date in the past
actual future volatility which refers to the volatility of a financial instrument
over a specified period starting at the current time and ending at a future date
(normally the expiry date of an options)
historical implied volatility which refers to the implied volatility observed from
historical prices of the financial instrument (normally options)
current implied volatility which refers to the implied volatility observed from
current prices of the financial instrument
future implied volatility which refers to the implied volatility observed from
future prices of the financial instrument
For a financial instrument whose price follows a random walk or wiener process the
width of the distribution increases as time increases This is because there is an
increasing profitability that the instruments price will be farther away from the initial
price as time increases However rather than increase linearly the volatility increases
with the square-root of time as time increases because some fluctuations are expected
to cancel each other out so the most likely deviation after twice the time will not be
twice the distance from zero
2103 Usefulness of volatility for Investors
Investors care about volatility for five reasons
1 The wider the swings in an investments price the harder emotionally it is to
not worry
2 Price volatility of a trading instrument can define position sizing in a portfolio
56
3 When certain cash flows from selling a security are needed at a specific future
date higher volatility means a greater chance of a shortfall
4 Higher volatility of returns while saving for retirement results in a wider
distribution of possible final portfolio values
5 Higher volatility of return when retired gives withdrawals a larger permanent
impact on the portfolios value
6 Price volatility presents opportunities to buy assets cheaply and sell when
overpriced
34
Chart 25 Trading Pattern of the Indian Stock Market
Source wwwbseindiacom
274 Types of Transactions
The flowchart below describes the types of transactions that can be carried out on the
Indian stock exchanges
Chart 26 Types of Transactions
Source wwwbseindiacom
Listed Securities of Public limited companies
Specified securities (forward List)
Equity shares of company that are
- Dividend paying
- growth orinted companies
- paid up capital of atleast Rs50 million
- Market capitalisation of atleast Rs100 million
- has more than 20000 shareholders
Non specicied Securities (Cash List)
equity shares of companies not covered in specified securities
Transactions on Indian Stock Exchanges
Spot Delivery Transactions
Forward Transactions
35
Spot Delivery Transactions
Includes transactions that require delivery and payment within stipulated time
period at the time of entering into the contract
This period shall not be more than 14 days following the date of the contract
Forward Transactions
Transactions in which delivery and payment can be extended by further period
of 14 days each
The overall period should not exceed 90 days from the date of contract
Transactions permitted only in case of specified shares
275 Indian stock exchange allows a member broker to perform
following activities
Act as an agent
Buy and sell securities for clients and charge commission for the same
Act as a trader or dealer as a principal
Buy and sell securities on their account and risk
276 Over The Counter Exchange of India (OTCEI)
Traditionally trading in Stock Exchanges in India followed a conventional style
where people used to gather at the Exchange and bids and offers were made by open
outcry This age-old trading mechanism in the Indian stock markets used to create
much functional inefficiency Lack of liquidity and transparency long settlement
periods and benami transactions are a few examples that adversely affected investors
In order to overcome these inefficiencies OTCEI was incorporated in 1990 under the
Companies Act 1956 OTCEI is the first screen based nationwide stock exchange in
India created by Unit Trust of India Industrial Credit and Investment Corporation of
India Industrial Development Bank of India SBI Capital Markets Industrial Finance
Corporation of India General Insurance Corporation and its subsidiaries and Can
Bank Financial Services
36
Chart 27 Securities traded on the OTCEI
Source wwwbseindiacom
Listed Securities
Securities of the companies listed on the OTC
Can be bought or sold at any OTC counter across India
Should not be listed anywhere else
Permitted Securities
Certain securities (Shares and debentures listed on other exchanges)
Unites of Mutual funds can be traded
Initiated Debentures
An equity holding a minimum of one lakh debentures of a particular scrip can
offer them for trading on the OTC
Advantages of OTCEI
Greater liquidity and lesser risk of intermediary charges due to widely spread trading
mechanism across India The screen-based scrip less trading ensures transparency and
accuracy of prices Faster settlement and transfer process as compared to other
exchanges Shorter allotment procedure (in case of a new issue) than other exchanges
277 National Stock Exchange
In order to lift the Indian stock market trading system at par with the international
standards On the basis of the recommendations of high powered Pherwani
Securities teaded on the
OTCEI
Listed Securities
Permitted Securities
Initiated Debentures
37
Committee the National Stock Exchange was incorporated in 1992 by Industrial
Development Bank of India Industrial Credit and Investment Corporation of India
Industrial Finance Corporation of India all Insurance Corporations selected
commercial banks and others
2771 NSE provides exposure to investors in two types of markets
namely
Wholesale debt market
Capital market
Wholesale Debt Market - Similar to money market operations debt market
operations involve institutional investors and corporate bodies entering into
transactions of high value in financial instruments like treasury bills government
securities commercial papers etc
Capital market- A capital market is a market for securities (debt or equity) where
business enterprises and governments can raise long term funds It is defined as a
market in which money is defined as a market in which money is provided for periods
longer than a year34 as the raising of short term funds takes place on other markets
Capital markets may be classified as primary markets and secondary markets In
primary markets new stock or bond issues are sold to investors via a mechanism
known as underwriting In the secondary markets existing securities are sold and
bought among investors or traders usually on a securities exchange over the counter
or elsewhere
278 Trading at NSE amp BSE
Fully automated screen-based trading mechanism
Strictly follows the principle of an order-driven market
Trading members are linked through a communication network
34 Steven M Sheffrin (2003) Economics Principles in action Upper Saddle River Pearson Prentice
Hall
38
This network allows them to execute trade from their offices
The prices at which the buyer and seller are willing to transact will appear on
the screen
When the prices match the transaction will be completed
A confirmation slip will be printed at the office of the trading member
2781 Advantages of trading at NSE amp BSE
Integrated network for trading in stock market of India
Fully automated screen based system that provides higher degree of
transparency
Investors can transact from any part of the country at uniform prices
Greater functional efficiency supported by totally computerized network
28 THE BOMBAY STOCK EXCHANGE
Formerly the Stock Exchange Mumbai popularly called Bombay Stock Exchange
or BSE is the oldest stock exchange in Asia and has the greatest number of listed
companies in the world with 4700 listed as of August 2007 35
It is located at Dalal Street Mumbai India On 31 December 2007 the equity market
capitalization of the BSE was US $ 179 trillion making it the largest stock exchange
in South Asia and the 12th largest in the world
With over 4700 Indian companies list on the stock exchange [10]
and it has a
significant trading volume The BSE SENSEX (SENSITIVE INDEX) also called the
―BSE 30 is a widely used market index in India and Asia Though many other
exchanges exist BSE and the National Stock Exchange of India account for most of
the trading in shares in India
35 World Federation of Exchanges (2007) wwwworld-exchangesorg
39
281 History of the Bombay Stock exchange
Trading in securities has been in vogue in India for a little over 200 years Trading in
securities dates back 1793 most of them being transactions in loan securities of the
East India Company The broking community prospered as there was a rise in prices
which led to a share mania during 1861-65 This bubble burst in 1865 when the
American Civil War ended The brokers realized that investor confidence in the
securities market could be sustained only by organizing themselves into a regulated
body with defined rules and regulations The realization resulted in formation of ―The
Native Share and Stock Brokerslsquo Association which later came to be known as the
Bombay Stock Exchange In 1875 these brokers assembled at a place now called
Dalal Street
The Bombay Stock Exchange is a voluntary nonprofit making association of broker
members It emerged as a premier stock exchange after the 1960 The increased pace
of industrialization caused by the two world wars protection to the domestic industry
and the governmentlsquos fiscal policies aided the growth of new issues which in turn
helped the BSE to prosper The BSE dominated the Indian Capital Market by
accounting for more than 60 per cent of the all Indian turn over
Until 1992 the BSE operated like a closed club of selected members With the
securities scam outburst in 1992 and the SEBI taking over the rains of the Stock
Market the BSE had to bring about changes in its operational policies Until March
1995 the BSE had an open outcry system of trading However when faced with stiff
competition from NSE the countrylsquos first modern computerized and professionally
managed stock exchange set up in 1994 the BSE had to change its system of trading
and operation
On 14 March 1995 the BSE turned to electronic trading whereby brokers trade using
computers This system is known as the BSE On-line Trading System (BOLT)
The introduction of BOLT helped in improving trading volumes significantly
reducing the spread between buy and sell orders better trading in odd lot shares fixed
income instruments and dealings in the renunciation of rights shares
40
In 1995 BOLT was limited to Mumbai whereas the NSE was operating at the
national level As a result the BSE submitted a proposal for allowing installation of
terminals connected to BOLT in centers outside Mumbai After rejecting the proposal
four times on 29 october 1996 the SEBI finally allowed the BSE to use its BOLT
system nationwide Later the BSE set up a central depository system to dematerialize
shares and promote demate Account (trading)
282 Hours of Operation
Beginning of the Day Session 800 to 900
Trading Session 900 to 1530
Position Transfer Session 1530 to 1550
Closing Session 1550 to 1605
Option Exercise Session 1605 to 1635
Margin Session 1635 to 1650
Query Session 1650 to1735
End of Day Session 1735
The hours of operation for the BSE quoted above are stated in terms of the local time
(ie GMT+530) in Mumbai India
BSElsquos normal trading sessions are on all days of the week except Saturdays Sundays
and Holidays declared by the Exchange in advance 36
283 Services of BSE
BSE also had a wide range of services to empower investors and facilitate smooth
transactions These services are as follows
2831 Investor Services
The Dept of investor services redresses grievances of investors BSE was the first
exchange in the country to provide an amount of Rs 1 million towards the investor
36 Asia Technical Analysis with Phil Smith wwwreutersindianet
41
protection fund it is an amount higher than that of any exchange in the country BSE
launched a nationwide investor awareness program ―Safe Investing in the Stock
Market under which 264 programmers were held in more than 200 cities
2832 The BSE Online Trading (BOLT)
BSE on line Trading (BOLT) facilities on-line screen based trading in securities
BOLT is currently operating in 25000 trader work stations located across over 399
cities in India
2833 BSEWEBXcom
In February 2001 BSE introduced the worldlsquos first centralized exchange based
Internet trading system BSEWEBXcom This initiative enables investors anywhere
in the world to trade on BSE platform
2834 Surveillance
BSElsquos Online Surveillance System (BOSS) monitors on a real time basis the price
movements volume position and real time measurements of the default risk market
reconstruct and generation of cross market alerts
2835 BSE Training Institute
BTI imparts capital market training and certification in collaboration with reputed
management institutes and universities It offers over 40 courses on various aspects of
the capital mark and financial sector More than 20000 people have attended the BTI
program
284 Awards
Fowling awards were given to BSE
The world council of Corporate Governance has awarded the Golden Peacock
Global CSR Award for BSElsquos initiatives in corporate social responsibility
The Annual Reports and Accounts of BSE for the year ended March 312006 and
42
March 312007 have been awarded the ICAI awards for excellence in financial
reporting
The Human Resource Management at BSE has won the Asia-Pacific HRM awards
for its efforts in employer branding through talent management at work health
management at work and excellence in HR through technology
Drawing from its rich past and its equally robust performance in the recent times
BSE will continue to remain an icon in the Indian Capital Market
285 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 days closing price is taken for computation of Index closure
The use of Index Closure Algorithm prevents any intentional manipulation of the
closing index value
286 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 affect the
index values The BSE Index Cell does the day-to-day maintenance of the index
within the broad index policy framework set by the BSE Index Committee The BSE
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 BSE Index Committee comprises
of capital market expert fund managers market participants and members of the BSE
Governing Board
43
287 On-Line Computation of the Index
During trading hours value of the Index is calculated and disseminated on real time
basis This is done automatically on the basis of prices at which trades in Index
constituents are executed
288 Adjustment for Bonus Rights and Newly Issued Capital
SENSEX calculation needs to be adjusted for issue of Bonus or 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 BSE Index Cell the base value is adjusted which is used to alter
market capitalization of the component stocks to arrive at the SENSEX value The
BSE Index Cell keeps a close watch on the events that might affect the index on a
regular basis and carries out daily maintenance of all the 19 Indices
2881 Adjustments for Rights Issues
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 (ex-right) price An offsetting or
proportionate adjustment is then made to the Base Market capitalization
2882 Adjustments for Bonus Issue
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
2883 Other Issues 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
buy-back of shares corporate restructuring etc
44
289 Listing Categories
Before badla was resumed in 1996 there were only two categories of securities listed
on the BSE the specified group of shares comprising The securities in which carry
forward deals were allowed and the cash group shares in which no carry forward deals
were permitted Later it was observed that the facility of carry forward was not being
used in all the 94 scrips in the specified group Hence after badla was resumed the
size of the specified group was reduced to 32 scrips on 3 April 1996 The BSE later
decided to regroup the existing A and B group shares into three categories The BSE
delisted 637 companies for a period of 3 years during 2004-05 for non-compliance of
listing agreements
A Group This group consists of large stock with turnover and high floating stock
with large market capitalization In other words scrips with more liquidity and high
networth are included in this group At present there are 150 scrips in this group
B1 Group This group includes scrips of quality companies with equity above Rs 3
crore with high growth potential and trading frequency No carry forward facility was
allowed in this group in June 2000 there were 1803 scrips in this group
B2 Group Scrips in this group were just like those of B1 but with fortnightly
settlement However in September 1996 the BSE introduced weekly settlement for all
scrips listed on the exchange thus doing away with the distinction between the B1 and
B2 groups On June 2000 there were 3219 scrips in this group
Z Group Subsequently a Z group was introduced in 1999 with scrips of companies
that do not meet the rules regulations and stipulations laid down by the exchange It
is a buyer beware company These are some 300 scrips in the group All Z category
stocks result in delivers
F Group A new Flsquo group pertaining to debt market segment was started with effect
from 9 September 1996
S Group The BSE reduced post-public issue capital base requirement from Rs10
crore to Rs3 crore to attract listing by companies with a smaller capital base It also
45
started a new trading segment small cap stock segment known as the Slsquo segment
Corporate with minimum turnover of an equal amount would be eligible to list scrips
on this segment In addition stocks listed on the regional exchanges would also be
able to list on the lsquoSlsquo segment subject to meeting certain criteria
2810 Base Market capitalization Adjustment
The formula for adjusting the Base Market capitalization is as follows
New Base Market Capitalization (NBMC)
New Market capitalization
NBMC = Old Base Market capitalization x mdashmdashmdashmdashmdashmdashmdashmdashmdashmdashmdash
Old Market capitalization
To illustrate suppose a company issues right shares which increases the market
capitalization of the shares of that company by say Rs100 crores The existing Base
Market capitalization (Old Base Market capitalization) say is Rs2450 crores and the
aggregate market capitalization of all the shares included in the index before the right
issue is made is say Rs4781 crore The New Base Market capitalization will then
be
2450x (4781+100)
_____________________ = Rs250124 crores
4781
This figure of Rs 250124 crore will be used as the Base Market capitalization for
calculating the index number from then onwards till the next base change becomes
necessary
Index Review Frequency
The BSE 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
29 STOCK MARKET INDEX
The stock market index is the most important indices of all as it measures overall
market sentiment through a set of stocks that representative of the market The stock
46
market index is a barometer of the market behavior It reflects direction and indicates
day-to-day fluctuations in stock prices The market index reflects expectations about
the behavior of the economy as a whole It is a precursor of economic cycles The
function of a stock index is to provide investors with information regarding the
average share price in the market An ideal index must represent changes in the prices
of the scrips and reflect price movements of typical shares for better market
representation Stock index is a barometer of a nationlsquos economic health as market
prices reflect expectations about the economylsquos performance Stock indices termed as
leading economic as they indicate what is going to happen in the economy in the
future The returns generated in the stock market are based on future expectations A
good market index incorporates a set of scrips which have high market capitalization
and high liquidity Market capitalization is the sum of the market value of all the
stocks included in the index The market value is derived by multiplying the price of
the share outstanding In other words the bid-ask spread is minimum The index on a
day is calculated as the percentage of the aggregate market value of the set of scrips
incorporated in the index on that day to the average market value of the same scrips
during the base period
291 Definition of an Index
A price index is such as the stock market price of the individual securities in the
market It reflects the overall price or return movements of a group of securities
Movements in an index are determined by sample weighting and computational
procedure Sample is normally generated by random selection or try a non random
selection technique designed to incorporate desired characteristics are used to select
sample shares rather than by completely random selection Major criteria for selection
are market activity due representation to various industrial groups and to major stock
exchanges
292 Global Stock Market Indices
2921 The Dow Jones Industrial averagersquos
It is the most widely watched and quoted index because of its long existence The
Dow has 30 constituents and it follows the methodology of price based weighted
47
Changes to stocks included in the Dow are infrequent three stocks were
addeddropped in 1991 four in 1997 and four in 1999 The addition of Microsoft and
Intel in 1999 was the first inclusion of Nasdaq market stocks to the Dow 30
2922 The Nasdaq composite index
The index is the market capitalization weighted of prices for all the stocks listed in the
Nasdaq stock market The Nasdaq composite began on 8 February 1971 with a base
of 100
2923 The Nasdaq 100 index
Nasdaq 100 comprises the largest computer software and telecom stocks by market
capitalization on the Nasdaq For a company to be included in the Nasdaq 100 it must
have a minimum average trading volume of 100000 shares per day and must have
been trading on a major exchange for at least a year or two
2924 The S amp P 500 index
This index comprises 500 biggest publicly traded companies in the US by market
capitalization Most money managers treat the S amp P 500 as a proxy for the US stock
market The S amp P 500 tries to cover all major areas of US economy To be included a
company must be profitable the prospective company must not be closely hold and
must have a large trading volume for its shares
2925 The FTSE 100
The FTSE 100 consists of the largest 100 companies by full market Value listed on
the London Stock Exchange The FTSE 100 is the benchmark index to indicate the
performance of the European market It is a market capitalization weighted index that
also considers the free float weighted of individual stocks before including them in
the index
2926 The MSCI Indices
Include the MSCIEAFE (Europe Australia and Far East) MSCI Europe MSCI
world MSCI (EMF) and MSCI Pacific Basin Indices
48
The MSCI world Index is a free float adjusted market capitalization index that is
designed to measure global developed market equity performance As of April 2002
the MSCI world Index consisted of the MSCI world Index consisted of the following
23 developed market country indices
Australia Austria Belgium Canada Denmark Finland France Germany Greece
Hong Kong Ireland Italy Japan Netherlands New Zealand Norway Singapore
Portugal Spain Sweden Switzerland United Kingdom and the United States of
America
293 Methodology for Calculating The Index
2931 Price Weighted Index
In this method the price of each stock in the index is summed up which is then
equated to an index starting value An arbitrary date is set as the base and the
Laspeyerlsquos Price Index which measures price changes against a fixed base period
quantity weight is used In case of a stock split the market price of the stock falls and
these results in less weighted in the index The Dow Jones Industrial Average and
Nikkie 225 are price-weighted indices
2932 Equal Weighting
In this method each stocklsquos percentage weight in the index is equal and hence all
stocks have an equal influence on the index movement The value line index at
Kansas City Board of Trade (KCBT) is an equal weighted index
2933 Market Capitalization Weighted
29331 Full Market Capitalization Method
In this method the number of shares outstanding multiplied by the market price of a
companylsquos share determines the scriplsquos weighted in the index The shares with the
highest market capitalization would have a higher weighted and would be most
influential in this type of index Eg S amp P 500 Index in USA and S amp P CNX Nify in
India
49
29332 Modified Capitalization Weighted
This method seeks to limit the influence of the largest stocks in the index which
otherwise would dominate the entire index This method sets a limit on the largest
stock or a group of stocks The NASDAQ 100 Index is calculated by using this
method
294 Free Float Market Capitalization Method
2941 Concept
Free float methodology refers to an index construction methodology that takes in to
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 Strategic holding government 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
All BSE indices with exception of BSE-PSU index have adopted the free-float
methodology
2942 Definition of Free Float
Share holding of investor that would not in the normal course come into the
open market for trading are treated as ―Controlling Strategic Holding and
hence not included in free float specifically the following categories of
holding are generally excluded from the definition of free float
Shares hold by foundersdirectorsacquires which has control element
Shares held by person with ―Controlling Interestlsquo
Shares held by Govt as promoters
50
Holding through the FDI Route
Strategic Stakes by private corporate bodiesindividuals
Equity held by employee welfare trusts
Locked-in-shares and shares which not be sold in the open market in normal
course
2943 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-agrave-Vis an investible
index This enables an apple-to-apple comparison thereby facilitating better
evaluation of performance of active managers
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 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
The free float methodology of index construction is considered to be an industry best
practice and all major index providers like MSCI FTSE SampP 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
51
29441 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 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 055 means that only 55 of the market
capitalization of the company will be considered for index calculation
Table 24 Free-float Bands
Free-Float Free-Float Factor Free-Float Free-Float Factor
gt0 - 5 005 gt50 - 55 055
gt5 - 10 010 gt55 - 60 060
gt10 - 15 015 gt60 - 65 065
gt15 - 20 020 gt65 - 70 070
gt20 - 25 025 gt70 - 75 075
gt25 - 30 030 gt75 - 80 080
gt30 - 35 035 gt80 - 85 085
gt35 - 40 040 gt85 - 90 090
gt40 - 45 045 gt90 - 95 095
gt45 - 50 050 gt95 - 100 100
Source wwwbseindiacom
295 BSE Indices
For the premier stock exchange that pioneered the securities transaction business
in India over a century of experience is a proud achievement A lot has changed since
1875 when 318 persons by paying a then princely amount of Re 1 became members
of what today is called Bombay Stock Exchange Limited (BSE) Over the decades
the stock market in the country has passed through good and bad periods The journey
52
in the 20th century has not been an easy one Till the decade of eighties there was no
measure or scale that could precisely measure the various ups and downs in the Indian
stock market BSE in 1986 came out with a Stock Index-SENSEX- that subsequently
became the barometer of the Indian stock market
The launch of SENSEX in 1986 was later followed up in January 1989 by
introduction of BSE National Index (Base 1983-84 = 100) It comprised 100 stocks
listed at five major stock exchanges in India - Mumbai Calcutta Delhi Ahmadabad
and Madras The BSE National Index was renamed BSE-100 Index from October 14
1996 and since then it is being calculated taking into consideration only the prices of
stocks listed at BSE BSE launched the dollar-linked version of BSE-100 index on
May 22 2006
With a view to provide a better representation of the increasing number of listed
companies larger market capitalization and the new industry sectors BSE launched
on 27th May 1994 two new index series viz the BSE-200 and the DOLLEX-200
Since then BSE has come a long way in attuning itself to the varied needs of
investors and market participants In order to fulfill the need for still broader
segment-specific and sector-specific indices BSE has continuously been increasing
the range of its indices BSE-500 Index and 5 sectorial indices were launched in 1999
In 2001 BSE launched BSE-PSU Index DOLLEX-30 and the countrys first free-
float based index - the BSE TEC Index Over the years BSE shifted all its indices to
the free-float methodology
BSE disseminates information on the Price-Earnings Ratio the Price to Book Value
Ratio and the Dividend Yield Percentage on day-to-day basis of all its major indices
The values of all BSE indices are updated on real time basis during market hours and
displayed through the BOLT system BSE website and news wire agencies
All BSE Indices are reviewed periodically by the BSE Index Committee This
Committee which comprises eminent independent finance professionals frames the
broad policy guidelines for the development and maintenance of all BSE indices The
BSE Index Cell carries out the day-to-day maintenance of all indices and conducts
research on development of new indices
53
2951 BSE-100 Index
A broad-based index the BSE-100 was formerly known as the BSE National index
This Index has 1983-84 as the base year and was launched in 1989 In line with the
shift of the BSE Indices to the globally accepted Free-Float methodology BSE-100
was shifted to Free-Float methodology effective from April 5 2004 The method of
computation of Free-Float index and determination of free-float factors is similar to
the methodology for SENSEX
Table 25 Index Specification
Base Year 1983-84
Base Index Value 100
Date of Launch 3-Jan-89
Method of calculation Launched on full market capitalization
method and effective April 05 2004
calculation method shifted to free-float
market capitalization
Number of scrips 100
Index calculation frequency Real Time
Source wwwbseindiacom
2952 Base Year
The financial year 1983-84 has been chosen as the base year The price stability
during that year and proximity to the index series were the main consideration for
choice of 1983-84 as the base year The base value was fixed at 100 points
2953 Dollex-100
BSE also calculates a dollar-linked version of SENSEX and historical values of this
index are available since its inception
2954 BSE-100 index - Scrip Selection Criteria
The general guidelines for selection of constituents in BSE-100 are as follows
Trading Frequency The scrip should have been traded on 95 of the trading days
54
in the last three months Exceptions can be made for extreme reasons like scrip
suspension etc
Final Rank The scrip should figure in the top 200 companies listed by final rank
The final rank is arrived at by assigning 75 weighted to the rank on the basis of
three-month average full market capitalization and 25 weighted to the liquidity rank
based on three-month average daily turnover amp three-month average impact cost
IndustrySector Representation Scrip selection would generally take into account a
balanced sectorial representation of the listed companies in the universe of BSE
Track Record In the opinion of the BSE Index Committee the company should
have an acceptable track record
210 STOCK MARKET VOLATILITY
2101 Meaning
Volatility is a measure for variation of price of a financial instrument over time
Historic volatility is derived from time series of past market prices An implied
volatility is derived from the market price of a market traded derivative (in particular
an option) Volatility does not measure the direction of price changes merely their
dispersion This is because when calculating standard deviation (or variance) all
differences are squared so that negative and positive differences are combined into
one quantity Two instruments with different volatilities may have the same expected
return but the instrument with higher volatility will have larger swings in values over
a given period of time
For example a lower volatility stock may have an expected (average) return of 7
with annual volatility of 5 This would indicate returns from approximately negative
3 to positive 17 most of the time (19 times out of 20 or 95 via a two standard
deviation rule) A higher volatility stock with the same expected return of 7 but
with annual volatility of 20 would indicate returns from approximately negative
33 to positive 47 most of the time (19 times out of 20 or 95) These estimates
assume a normal distribution in reality stocks are found to be leptokurtotic
55
2102 Terminology used in volatility
Volatility as described here refers to the actual current volatility of a financial
instrument for a specified period (for example 30 days or 90 days) It is the volatility
of a financial instrument based on historical prices over the specified period with the
last observation the most recent price This phrase is used particularly when it is
wished to distinguish between the actual current volatility of an instrument and
actual historical volatility which refers to the volatility of a financial instrument
over a specified period but with the last observation on a date in the past
actual future volatility which refers to the volatility of a financial instrument
over a specified period starting at the current time and ending at a future date
(normally the expiry date of an options)
historical implied volatility which refers to the implied volatility observed from
historical prices of the financial instrument (normally options)
current implied volatility which refers to the implied volatility observed from
current prices of the financial instrument
future implied volatility which refers to the implied volatility observed from
future prices of the financial instrument
For a financial instrument whose price follows a random walk or wiener process the
width of the distribution increases as time increases This is because there is an
increasing profitability that the instruments price will be farther away from the initial
price as time increases However rather than increase linearly the volatility increases
with the square-root of time as time increases because some fluctuations are expected
to cancel each other out so the most likely deviation after twice the time will not be
twice the distance from zero
2103 Usefulness of volatility for Investors
Investors care about volatility for five reasons
1 The wider the swings in an investments price the harder emotionally it is to
not worry
2 Price volatility of a trading instrument can define position sizing in a portfolio
56
3 When certain cash flows from selling a security are needed at a specific future
date higher volatility means a greater chance of a shortfall
4 Higher volatility of returns while saving for retirement results in a wider
distribution of possible final portfolio values
5 Higher volatility of return when retired gives withdrawals a larger permanent
impact on the portfolios value
6 Price volatility presents opportunities to buy assets cheaply and sell when
overpriced
35
Spot Delivery Transactions
Includes transactions that require delivery and payment within stipulated time
period at the time of entering into the contract
This period shall not be more than 14 days following the date of the contract
Forward Transactions
Transactions in which delivery and payment can be extended by further period
of 14 days each
The overall period should not exceed 90 days from the date of contract
Transactions permitted only in case of specified shares
275 Indian stock exchange allows a member broker to perform
following activities
Act as an agent
Buy and sell securities for clients and charge commission for the same
Act as a trader or dealer as a principal
Buy and sell securities on their account and risk
276 Over The Counter Exchange of India (OTCEI)
Traditionally trading in Stock Exchanges in India followed a conventional style
where people used to gather at the Exchange and bids and offers were made by open
outcry This age-old trading mechanism in the Indian stock markets used to create
much functional inefficiency Lack of liquidity and transparency long settlement
periods and benami transactions are a few examples that adversely affected investors
In order to overcome these inefficiencies OTCEI was incorporated in 1990 under the
Companies Act 1956 OTCEI is the first screen based nationwide stock exchange in
India created by Unit Trust of India Industrial Credit and Investment Corporation of
India Industrial Development Bank of India SBI Capital Markets Industrial Finance
Corporation of India General Insurance Corporation and its subsidiaries and Can
Bank Financial Services
36
Chart 27 Securities traded on the OTCEI
Source wwwbseindiacom
Listed Securities
Securities of the companies listed on the OTC
Can be bought or sold at any OTC counter across India
Should not be listed anywhere else
Permitted Securities
Certain securities (Shares and debentures listed on other exchanges)
Unites of Mutual funds can be traded
Initiated Debentures
An equity holding a minimum of one lakh debentures of a particular scrip can
offer them for trading on the OTC
Advantages of OTCEI
Greater liquidity and lesser risk of intermediary charges due to widely spread trading
mechanism across India The screen-based scrip less trading ensures transparency and
accuracy of prices Faster settlement and transfer process as compared to other
exchanges Shorter allotment procedure (in case of a new issue) than other exchanges
277 National Stock Exchange
In order to lift the Indian stock market trading system at par with the international
standards On the basis of the recommendations of high powered Pherwani
Securities teaded on the
OTCEI
Listed Securities
Permitted Securities
Initiated Debentures
37
Committee the National Stock Exchange was incorporated in 1992 by Industrial
Development Bank of India Industrial Credit and Investment Corporation of India
Industrial Finance Corporation of India all Insurance Corporations selected
commercial banks and others
2771 NSE provides exposure to investors in two types of markets
namely
Wholesale debt market
Capital market
Wholesale Debt Market - Similar to money market operations debt market
operations involve institutional investors and corporate bodies entering into
transactions of high value in financial instruments like treasury bills government
securities commercial papers etc
Capital market- A capital market is a market for securities (debt or equity) where
business enterprises and governments can raise long term funds It is defined as a
market in which money is defined as a market in which money is provided for periods
longer than a year34 as the raising of short term funds takes place on other markets
Capital markets may be classified as primary markets and secondary markets In
primary markets new stock or bond issues are sold to investors via a mechanism
known as underwriting In the secondary markets existing securities are sold and
bought among investors or traders usually on a securities exchange over the counter
or elsewhere
278 Trading at NSE amp BSE
Fully automated screen-based trading mechanism
Strictly follows the principle of an order-driven market
Trading members are linked through a communication network
34 Steven M Sheffrin (2003) Economics Principles in action Upper Saddle River Pearson Prentice
Hall
38
This network allows them to execute trade from their offices
The prices at which the buyer and seller are willing to transact will appear on
the screen
When the prices match the transaction will be completed
A confirmation slip will be printed at the office of the trading member
2781 Advantages of trading at NSE amp BSE
Integrated network for trading in stock market of India
Fully automated screen based system that provides higher degree of
transparency
Investors can transact from any part of the country at uniform prices
Greater functional efficiency supported by totally computerized network
28 THE BOMBAY STOCK EXCHANGE
Formerly the Stock Exchange Mumbai popularly called Bombay Stock Exchange
or BSE is the oldest stock exchange in Asia and has the greatest number of listed
companies in the world with 4700 listed as of August 2007 35
It is located at Dalal Street Mumbai India On 31 December 2007 the equity market
capitalization of the BSE was US $ 179 trillion making it the largest stock exchange
in South Asia and the 12th largest in the world
With over 4700 Indian companies list on the stock exchange [10]
and it has a
significant trading volume The BSE SENSEX (SENSITIVE INDEX) also called the
―BSE 30 is a widely used market index in India and Asia Though many other
exchanges exist BSE and the National Stock Exchange of India account for most of
the trading in shares in India
35 World Federation of Exchanges (2007) wwwworld-exchangesorg
39
281 History of the Bombay Stock exchange
Trading in securities has been in vogue in India for a little over 200 years Trading in
securities dates back 1793 most of them being transactions in loan securities of the
East India Company The broking community prospered as there was a rise in prices
which led to a share mania during 1861-65 This bubble burst in 1865 when the
American Civil War ended The brokers realized that investor confidence in the
securities market could be sustained only by organizing themselves into a regulated
body with defined rules and regulations The realization resulted in formation of ―The
Native Share and Stock Brokerslsquo Association which later came to be known as the
Bombay Stock Exchange In 1875 these brokers assembled at a place now called
Dalal Street
The Bombay Stock Exchange is a voluntary nonprofit making association of broker
members It emerged as a premier stock exchange after the 1960 The increased pace
of industrialization caused by the two world wars protection to the domestic industry
and the governmentlsquos fiscal policies aided the growth of new issues which in turn
helped the BSE to prosper The BSE dominated the Indian Capital Market by
accounting for more than 60 per cent of the all Indian turn over
Until 1992 the BSE operated like a closed club of selected members With the
securities scam outburst in 1992 and the SEBI taking over the rains of the Stock
Market the BSE had to bring about changes in its operational policies Until March
1995 the BSE had an open outcry system of trading However when faced with stiff
competition from NSE the countrylsquos first modern computerized and professionally
managed stock exchange set up in 1994 the BSE had to change its system of trading
and operation
On 14 March 1995 the BSE turned to electronic trading whereby brokers trade using
computers This system is known as the BSE On-line Trading System (BOLT)
The introduction of BOLT helped in improving trading volumes significantly
reducing the spread between buy and sell orders better trading in odd lot shares fixed
income instruments and dealings in the renunciation of rights shares
40
In 1995 BOLT was limited to Mumbai whereas the NSE was operating at the
national level As a result the BSE submitted a proposal for allowing installation of
terminals connected to BOLT in centers outside Mumbai After rejecting the proposal
four times on 29 october 1996 the SEBI finally allowed the BSE to use its BOLT
system nationwide Later the BSE set up a central depository system to dematerialize
shares and promote demate Account (trading)
282 Hours of Operation
Beginning of the Day Session 800 to 900
Trading Session 900 to 1530
Position Transfer Session 1530 to 1550
Closing Session 1550 to 1605
Option Exercise Session 1605 to 1635
Margin Session 1635 to 1650
Query Session 1650 to1735
End of Day Session 1735
The hours of operation for the BSE quoted above are stated in terms of the local time
(ie GMT+530) in Mumbai India
BSElsquos normal trading sessions are on all days of the week except Saturdays Sundays
and Holidays declared by the Exchange in advance 36
283 Services of BSE
BSE also had a wide range of services to empower investors and facilitate smooth
transactions These services are as follows
2831 Investor Services
The Dept of investor services redresses grievances of investors BSE was the first
exchange in the country to provide an amount of Rs 1 million towards the investor
36 Asia Technical Analysis with Phil Smith wwwreutersindianet
41
protection fund it is an amount higher than that of any exchange in the country BSE
launched a nationwide investor awareness program ―Safe Investing in the Stock
Market under which 264 programmers were held in more than 200 cities
2832 The BSE Online Trading (BOLT)
BSE on line Trading (BOLT) facilities on-line screen based trading in securities
BOLT is currently operating in 25000 trader work stations located across over 399
cities in India
2833 BSEWEBXcom
In February 2001 BSE introduced the worldlsquos first centralized exchange based
Internet trading system BSEWEBXcom This initiative enables investors anywhere
in the world to trade on BSE platform
2834 Surveillance
BSElsquos Online Surveillance System (BOSS) monitors on a real time basis the price
movements volume position and real time measurements of the default risk market
reconstruct and generation of cross market alerts
2835 BSE Training Institute
BTI imparts capital market training and certification in collaboration with reputed
management institutes and universities It offers over 40 courses on various aspects of
the capital mark and financial sector More than 20000 people have attended the BTI
program
284 Awards
Fowling awards were given to BSE
The world council of Corporate Governance has awarded the Golden Peacock
Global CSR Award for BSElsquos initiatives in corporate social responsibility
The Annual Reports and Accounts of BSE for the year ended March 312006 and
42
March 312007 have been awarded the ICAI awards for excellence in financial
reporting
The Human Resource Management at BSE has won the Asia-Pacific HRM awards
for its efforts in employer branding through talent management at work health
management at work and excellence in HR through technology
Drawing from its rich past and its equally robust performance in the recent times
BSE will continue to remain an icon in the Indian Capital Market
285 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 days closing price is taken for computation of Index closure
The use of Index Closure Algorithm prevents any intentional manipulation of the
closing index value
286 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 affect the
index values The BSE Index Cell does the day-to-day maintenance of the index
within the broad index policy framework set by the BSE Index Committee The BSE
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 BSE Index Committee comprises
of capital market expert fund managers market participants and members of the BSE
Governing Board
43
287 On-Line Computation of the Index
During trading hours value of the Index is calculated and disseminated on real time
basis This is done automatically on the basis of prices at which trades in Index
constituents are executed
288 Adjustment for Bonus Rights and Newly Issued Capital
SENSEX calculation needs to be adjusted for issue of Bonus or 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 BSE Index Cell the base value is adjusted which is used to alter
market capitalization of the component stocks to arrive at the SENSEX value The
BSE Index Cell keeps a close watch on the events that might affect the index on a
regular basis and carries out daily maintenance of all the 19 Indices
2881 Adjustments for Rights Issues
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 (ex-right) price An offsetting or
proportionate adjustment is then made to the Base Market capitalization
2882 Adjustments for Bonus Issue
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
2883 Other Issues 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
buy-back of shares corporate restructuring etc
44
289 Listing Categories
Before badla was resumed in 1996 there were only two categories of securities listed
on the BSE the specified group of shares comprising The securities in which carry
forward deals were allowed and the cash group shares in which no carry forward deals
were permitted Later it was observed that the facility of carry forward was not being
used in all the 94 scrips in the specified group Hence after badla was resumed the
size of the specified group was reduced to 32 scrips on 3 April 1996 The BSE later
decided to regroup the existing A and B group shares into three categories The BSE
delisted 637 companies for a period of 3 years during 2004-05 for non-compliance of
listing agreements
A Group This group consists of large stock with turnover and high floating stock
with large market capitalization In other words scrips with more liquidity and high
networth are included in this group At present there are 150 scrips in this group
B1 Group This group includes scrips of quality companies with equity above Rs 3
crore with high growth potential and trading frequency No carry forward facility was
allowed in this group in June 2000 there were 1803 scrips in this group
B2 Group Scrips in this group were just like those of B1 but with fortnightly
settlement However in September 1996 the BSE introduced weekly settlement for all
scrips listed on the exchange thus doing away with the distinction between the B1 and
B2 groups On June 2000 there were 3219 scrips in this group
Z Group Subsequently a Z group was introduced in 1999 with scrips of companies
that do not meet the rules regulations and stipulations laid down by the exchange It
is a buyer beware company These are some 300 scrips in the group All Z category
stocks result in delivers
F Group A new Flsquo group pertaining to debt market segment was started with effect
from 9 September 1996
S Group The BSE reduced post-public issue capital base requirement from Rs10
crore to Rs3 crore to attract listing by companies with a smaller capital base It also
45
started a new trading segment small cap stock segment known as the Slsquo segment
Corporate with minimum turnover of an equal amount would be eligible to list scrips
on this segment In addition stocks listed on the regional exchanges would also be
able to list on the lsquoSlsquo segment subject to meeting certain criteria
2810 Base Market capitalization Adjustment
The formula for adjusting the Base Market capitalization is as follows
New Base Market Capitalization (NBMC)
New Market capitalization
NBMC = Old Base Market capitalization x mdashmdashmdashmdashmdashmdashmdashmdashmdashmdashmdash
Old Market capitalization
To illustrate suppose a company issues right shares which increases the market
capitalization of the shares of that company by say Rs100 crores The existing Base
Market capitalization (Old Base Market capitalization) say is Rs2450 crores and the
aggregate market capitalization of all the shares included in the index before the right
issue is made is say Rs4781 crore The New Base Market capitalization will then
be
2450x (4781+100)
_____________________ = Rs250124 crores
4781
This figure of Rs 250124 crore will be used as the Base Market capitalization for
calculating the index number from then onwards till the next base change becomes
necessary
Index Review Frequency
The BSE 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
29 STOCK MARKET INDEX
The stock market index is the most important indices of all as it measures overall
market sentiment through a set of stocks that representative of the market The stock
46
market index is a barometer of the market behavior It reflects direction and indicates
day-to-day fluctuations in stock prices The market index reflects expectations about
the behavior of the economy as a whole It is a precursor of economic cycles The
function of a stock index is to provide investors with information regarding the
average share price in the market An ideal index must represent changes in the prices
of the scrips and reflect price movements of typical shares for better market
representation Stock index is a barometer of a nationlsquos economic health as market
prices reflect expectations about the economylsquos performance Stock indices termed as
leading economic as they indicate what is going to happen in the economy in the
future The returns generated in the stock market are based on future expectations A
good market index incorporates a set of scrips which have high market capitalization
and high liquidity Market capitalization is the sum of the market value of all the
stocks included in the index The market value is derived by multiplying the price of
the share outstanding In other words the bid-ask spread is minimum The index on a
day is calculated as the percentage of the aggregate market value of the set of scrips
incorporated in the index on that day to the average market value of the same scrips
during the base period
291 Definition of an Index
A price index is such as the stock market price of the individual securities in the
market It reflects the overall price or return movements of a group of securities
Movements in an index are determined by sample weighting and computational
procedure Sample is normally generated by random selection or try a non random
selection technique designed to incorporate desired characteristics are used to select
sample shares rather than by completely random selection Major criteria for selection
are market activity due representation to various industrial groups and to major stock
exchanges
292 Global Stock Market Indices
2921 The Dow Jones Industrial averagersquos
It is the most widely watched and quoted index because of its long existence The
Dow has 30 constituents and it follows the methodology of price based weighted
47
Changes to stocks included in the Dow are infrequent three stocks were
addeddropped in 1991 four in 1997 and four in 1999 The addition of Microsoft and
Intel in 1999 was the first inclusion of Nasdaq market stocks to the Dow 30
2922 The Nasdaq composite index
The index is the market capitalization weighted of prices for all the stocks listed in the
Nasdaq stock market The Nasdaq composite began on 8 February 1971 with a base
of 100
2923 The Nasdaq 100 index
Nasdaq 100 comprises the largest computer software and telecom stocks by market
capitalization on the Nasdaq For a company to be included in the Nasdaq 100 it must
have a minimum average trading volume of 100000 shares per day and must have
been trading on a major exchange for at least a year or two
2924 The S amp P 500 index
This index comprises 500 biggest publicly traded companies in the US by market
capitalization Most money managers treat the S amp P 500 as a proxy for the US stock
market The S amp P 500 tries to cover all major areas of US economy To be included a
company must be profitable the prospective company must not be closely hold and
must have a large trading volume for its shares
2925 The FTSE 100
The FTSE 100 consists of the largest 100 companies by full market Value listed on
the London Stock Exchange The FTSE 100 is the benchmark index to indicate the
performance of the European market It is a market capitalization weighted index that
also considers the free float weighted of individual stocks before including them in
the index
2926 The MSCI Indices
Include the MSCIEAFE (Europe Australia and Far East) MSCI Europe MSCI
world MSCI (EMF) and MSCI Pacific Basin Indices
48
The MSCI world Index is a free float adjusted market capitalization index that is
designed to measure global developed market equity performance As of April 2002
the MSCI world Index consisted of the MSCI world Index consisted of the following
23 developed market country indices
Australia Austria Belgium Canada Denmark Finland France Germany Greece
Hong Kong Ireland Italy Japan Netherlands New Zealand Norway Singapore
Portugal Spain Sweden Switzerland United Kingdom and the United States of
America
293 Methodology for Calculating The Index
2931 Price Weighted Index
In this method the price of each stock in the index is summed up which is then
equated to an index starting value An arbitrary date is set as the base and the
Laspeyerlsquos Price Index which measures price changes against a fixed base period
quantity weight is used In case of a stock split the market price of the stock falls and
these results in less weighted in the index The Dow Jones Industrial Average and
Nikkie 225 are price-weighted indices
2932 Equal Weighting
In this method each stocklsquos percentage weight in the index is equal and hence all
stocks have an equal influence on the index movement The value line index at
Kansas City Board of Trade (KCBT) is an equal weighted index
2933 Market Capitalization Weighted
29331 Full Market Capitalization Method
In this method the number of shares outstanding multiplied by the market price of a
companylsquos share determines the scriplsquos weighted in the index The shares with the
highest market capitalization would have a higher weighted and would be most
influential in this type of index Eg S amp P 500 Index in USA and S amp P CNX Nify in
India
49
29332 Modified Capitalization Weighted
This method seeks to limit the influence of the largest stocks in the index which
otherwise would dominate the entire index This method sets a limit on the largest
stock or a group of stocks The NASDAQ 100 Index is calculated by using this
method
294 Free Float Market Capitalization Method
2941 Concept
Free float methodology refers to an index construction methodology that takes in to
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 Strategic holding government 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
All BSE indices with exception of BSE-PSU index have adopted the free-float
methodology
2942 Definition of Free Float
Share holding of investor that would not in the normal course come into the
open market for trading are treated as ―Controlling Strategic Holding and
hence not included in free float specifically the following categories of
holding are generally excluded from the definition of free float
Shares hold by foundersdirectorsacquires which has control element
Shares held by person with ―Controlling Interestlsquo
Shares held by Govt as promoters
50
Holding through the FDI Route
Strategic Stakes by private corporate bodiesindividuals
Equity held by employee welfare trusts
Locked-in-shares and shares which not be sold in the open market in normal
course
2943 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-agrave-Vis an investible
index This enables an apple-to-apple comparison thereby facilitating better
evaluation of performance of active managers
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 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
The free float methodology of index construction is considered to be an industry best
practice and all major index providers like MSCI FTSE SampP 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
51
29441 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 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 055 means that only 55 of the market
capitalization of the company will be considered for index calculation
Table 24 Free-float Bands
Free-Float Free-Float Factor Free-Float Free-Float Factor
gt0 - 5 005 gt50 - 55 055
gt5 - 10 010 gt55 - 60 060
gt10 - 15 015 gt60 - 65 065
gt15 - 20 020 gt65 - 70 070
gt20 - 25 025 gt70 - 75 075
gt25 - 30 030 gt75 - 80 080
gt30 - 35 035 gt80 - 85 085
gt35 - 40 040 gt85 - 90 090
gt40 - 45 045 gt90 - 95 095
gt45 - 50 050 gt95 - 100 100
Source wwwbseindiacom
295 BSE Indices
For the premier stock exchange that pioneered the securities transaction business
in India over a century of experience is a proud achievement A lot has changed since
1875 when 318 persons by paying a then princely amount of Re 1 became members
of what today is called Bombay Stock Exchange Limited (BSE) Over the decades
the stock market in the country has passed through good and bad periods The journey
52
in the 20th century has not been an easy one Till the decade of eighties there was no
measure or scale that could precisely measure the various ups and downs in the Indian
stock market BSE in 1986 came out with a Stock Index-SENSEX- that subsequently
became the barometer of the Indian stock market
The launch of SENSEX in 1986 was later followed up in January 1989 by
introduction of BSE National Index (Base 1983-84 = 100) It comprised 100 stocks
listed at five major stock exchanges in India - Mumbai Calcutta Delhi Ahmadabad
and Madras The BSE National Index was renamed BSE-100 Index from October 14
1996 and since then it is being calculated taking into consideration only the prices of
stocks listed at BSE BSE launched the dollar-linked version of BSE-100 index on
May 22 2006
With a view to provide a better representation of the increasing number of listed
companies larger market capitalization and the new industry sectors BSE launched
on 27th May 1994 two new index series viz the BSE-200 and the DOLLEX-200
Since then BSE has come a long way in attuning itself to the varied needs of
investors and market participants In order to fulfill the need for still broader
segment-specific and sector-specific indices BSE has continuously been increasing
the range of its indices BSE-500 Index and 5 sectorial indices were launched in 1999
In 2001 BSE launched BSE-PSU Index DOLLEX-30 and the countrys first free-
float based index - the BSE TEC Index Over the years BSE shifted all its indices to
the free-float methodology
BSE disseminates information on the Price-Earnings Ratio the Price to Book Value
Ratio and the Dividend Yield Percentage on day-to-day basis of all its major indices
The values of all BSE indices are updated on real time basis during market hours and
displayed through the BOLT system BSE website and news wire agencies
All BSE Indices are reviewed periodically by the BSE Index Committee This
Committee which comprises eminent independent finance professionals frames the
broad policy guidelines for the development and maintenance of all BSE indices The
BSE Index Cell carries out the day-to-day maintenance of all indices and conducts
research on development of new indices
53
2951 BSE-100 Index
A broad-based index the BSE-100 was formerly known as the BSE National index
This Index has 1983-84 as the base year and was launched in 1989 In line with the
shift of the BSE Indices to the globally accepted Free-Float methodology BSE-100
was shifted to Free-Float methodology effective from April 5 2004 The method of
computation of Free-Float index and determination of free-float factors is similar to
the methodology for SENSEX
Table 25 Index Specification
Base Year 1983-84
Base Index Value 100
Date of Launch 3-Jan-89
Method of calculation Launched on full market capitalization
method and effective April 05 2004
calculation method shifted to free-float
market capitalization
Number of scrips 100
Index calculation frequency Real Time
Source wwwbseindiacom
2952 Base Year
The financial year 1983-84 has been chosen as the base year The price stability
during that year and proximity to the index series were the main consideration for
choice of 1983-84 as the base year The base value was fixed at 100 points
2953 Dollex-100
BSE also calculates a dollar-linked version of SENSEX and historical values of this
index are available since its inception
2954 BSE-100 index - Scrip Selection Criteria
The general guidelines for selection of constituents in BSE-100 are as follows
Trading Frequency The scrip should have been traded on 95 of the trading days
54
in the last three months Exceptions can be made for extreme reasons like scrip
suspension etc
Final Rank The scrip should figure in the top 200 companies listed by final rank
The final rank is arrived at by assigning 75 weighted to the rank on the basis of
three-month average full market capitalization and 25 weighted to the liquidity rank
based on three-month average daily turnover amp three-month average impact cost
IndustrySector Representation Scrip selection would generally take into account a
balanced sectorial representation of the listed companies in the universe of BSE
Track Record In the opinion of the BSE Index Committee the company should
have an acceptable track record
210 STOCK MARKET VOLATILITY
2101 Meaning
Volatility is a measure for variation of price of a financial instrument over time
Historic volatility is derived from time series of past market prices An implied
volatility is derived from the market price of a market traded derivative (in particular
an option) Volatility does not measure the direction of price changes merely their
dispersion This is because when calculating standard deviation (or variance) all
differences are squared so that negative and positive differences are combined into
one quantity Two instruments with different volatilities may have the same expected
return but the instrument with higher volatility will have larger swings in values over
a given period of time
For example a lower volatility stock may have an expected (average) return of 7
with annual volatility of 5 This would indicate returns from approximately negative
3 to positive 17 most of the time (19 times out of 20 or 95 via a two standard
deviation rule) A higher volatility stock with the same expected return of 7 but
with annual volatility of 20 would indicate returns from approximately negative
33 to positive 47 most of the time (19 times out of 20 or 95) These estimates
assume a normal distribution in reality stocks are found to be leptokurtotic
55
2102 Terminology used in volatility
Volatility as described here refers to the actual current volatility of a financial
instrument for a specified period (for example 30 days or 90 days) It is the volatility
of a financial instrument based on historical prices over the specified period with the
last observation the most recent price This phrase is used particularly when it is
wished to distinguish between the actual current volatility of an instrument and
actual historical volatility which refers to the volatility of a financial instrument
over a specified period but with the last observation on a date in the past
actual future volatility which refers to the volatility of a financial instrument
over a specified period starting at the current time and ending at a future date
(normally the expiry date of an options)
historical implied volatility which refers to the implied volatility observed from
historical prices of the financial instrument (normally options)
current implied volatility which refers to the implied volatility observed from
current prices of the financial instrument
future implied volatility which refers to the implied volatility observed from
future prices of the financial instrument
For a financial instrument whose price follows a random walk or wiener process the
width of the distribution increases as time increases This is because there is an
increasing profitability that the instruments price will be farther away from the initial
price as time increases However rather than increase linearly the volatility increases
with the square-root of time as time increases because some fluctuations are expected
to cancel each other out so the most likely deviation after twice the time will not be
twice the distance from zero
2103 Usefulness of volatility for Investors
Investors care about volatility for five reasons
1 The wider the swings in an investments price the harder emotionally it is to
not worry
2 Price volatility of a trading instrument can define position sizing in a portfolio
56
3 When certain cash flows from selling a security are needed at a specific future
date higher volatility means a greater chance of a shortfall
4 Higher volatility of returns while saving for retirement results in a wider
distribution of possible final portfolio values
5 Higher volatility of return when retired gives withdrawals a larger permanent
impact on the portfolios value
6 Price volatility presents opportunities to buy assets cheaply and sell when
overpriced
36
Chart 27 Securities traded on the OTCEI
Source wwwbseindiacom
Listed Securities
Securities of the companies listed on the OTC
Can be bought or sold at any OTC counter across India
Should not be listed anywhere else
Permitted Securities
Certain securities (Shares and debentures listed on other exchanges)
Unites of Mutual funds can be traded
Initiated Debentures
An equity holding a minimum of one lakh debentures of a particular scrip can
offer them for trading on the OTC
Advantages of OTCEI
Greater liquidity and lesser risk of intermediary charges due to widely spread trading
mechanism across India The screen-based scrip less trading ensures transparency and
accuracy of prices Faster settlement and transfer process as compared to other
exchanges Shorter allotment procedure (in case of a new issue) than other exchanges
277 National Stock Exchange
In order to lift the Indian stock market trading system at par with the international
standards On the basis of the recommendations of high powered Pherwani
Securities teaded on the
OTCEI
Listed Securities
Permitted Securities
Initiated Debentures
37
Committee the National Stock Exchange was incorporated in 1992 by Industrial
Development Bank of India Industrial Credit and Investment Corporation of India
Industrial Finance Corporation of India all Insurance Corporations selected
commercial banks and others
2771 NSE provides exposure to investors in two types of markets
namely
Wholesale debt market
Capital market
Wholesale Debt Market - Similar to money market operations debt market
operations involve institutional investors and corporate bodies entering into
transactions of high value in financial instruments like treasury bills government
securities commercial papers etc
Capital market- A capital market is a market for securities (debt or equity) where
business enterprises and governments can raise long term funds It is defined as a
market in which money is defined as a market in which money is provided for periods
longer than a year34 as the raising of short term funds takes place on other markets
Capital markets may be classified as primary markets and secondary markets In
primary markets new stock or bond issues are sold to investors via a mechanism
known as underwriting In the secondary markets existing securities are sold and
bought among investors or traders usually on a securities exchange over the counter
or elsewhere
278 Trading at NSE amp BSE
Fully automated screen-based trading mechanism
Strictly follows the principle of an order-driven market
Trading members are linked through a communication network
34 Steven M Sheffrin (2003) Economics Principles in action Upper Saddle River Pearson Prentice
Hall
38
This network allows them to execute trade from their offices
The prices at which the buyer and seller are willing to transact will appear on
the screen
When the prices match the transaction will be completed
A confirmation slip will be printed at the office of the trading member
2781 Advantages of trading at NSE amp BSE
Integrated network for trading in stock market of India
Fully automated screen based system that provides higher degree of
transparency
Investors can transact from any part of the country at uniform prices
Greater functional efficiency supported by totally computerized network
28 THE BOMBAY STOCK EXCHANGE
Formerly the Stock Exchange Mumbai popularly called Bombay Stock Exchange
or BSE is the oldest stock exchange in Asia and has the greatest number of listed
companies in the world with 4700 listed as of August 2007 35
It is located at Dalal Street Mumbai India On 31 December 2007 the equity market
capitalization of the BSE was US $ 179 trillion making it the largest stock exchange
in South Asia and the 12th largest in the world
With over 4700 Indian companies list on the stock exchange [10]
and it has a
significant trading volume The BSE SENSEX (SENSITIVE INDEX) also called the
―BSE 30 is a widely used market index in India and Asia Though many other
exchanges exist BSE and the National Stock Exchange of India account for most of
the trading in shares in India
35 World Federation of Exchanges (2007) wwwworld-exchangesorg
39
281 History of the Bombay Stock exchange
Trading in securities has been in vogue in India for a little over 200 years Trading in
securities dates back 1793 most of them being transactions in loan securities of the
East India Company The broking community prospered as there was a rise in prices
which led to a share mania during 1861-65 This bubble burst in 1865 when the
American Civil War ended The brokers realized that investor confidence in the
securities market could be sustained only by organizing themselves into a regulated
body with defined rules and regulations The realization resulted in formation of ―The
Native Share and Stock Brokerslsquo Association which later came to be known as the
Bombay Stock Exchange In 1875 these brokers assembled at a place now called
Dalal Street
The Bombay Stock Exchange is a voluntary nonprofit making association of broker
members It emerged as a premier stock exchange after the 1960 The increased pace
of industrialization caused by the two world wars protection to the domestic industry
and the governmentlsquos fiscal policies aided the growth of new issues which in turn
helped the BSE to prosper The BSE dominated the Indian Capital Market by
accounting for more than 60 per cent of the all Indian turn over
Until 1992 the BSE operated like a closed club of selected members With the
securities scam outburst in 1992 and the SEBI taking over the rains of the Stock
Market the BSE had to bring about changes in its operational policies Until March
1995 the BSE had an open outcry system of trading However when faced with stiff
competition from NSE the countrylsquos first modern computerized and professionally
managed stock exchange set up in 1994 the BSE had to change its system of trading
and operation
On 14 March 1995 the BSE turned to electronic trading whereby brokers trade using
computers This system is known as the BSE On-line Trading System (BOLT)
The introduction of BOLT helped in improving trading volumes significantly
reducing the spread between buy and sell orders better trading in odd lot shares fixed
income instruments and dealings in the renunciation of rights shares
40
In 1995 BOLT was limited to Mumbai whereas the NSE was operating at the
national level As a result the BSE submitted a proposal for allowing installation of
terminals connected to BOLT in centers outside Mumbai After rejecting the proposal
four times on 29 october 1996 the SEBI finally allowed the BSE to use its BOLT
system nationwide Later the BSE set up a central depository system to dematerialize
shares and promote demate Account (trading)
282 Hours of Operation
Beginning of the Day Session 800 to 900
Trading Session 900 to 1530
Position Transfer Session 1530 to 1550
Closing Session 1550 to 1605
Option Exercise Session 1605 to 1635
Margin Session 1635 to 1650
Query Session 1650 to1735
End of Day Session 1735
The hours of operation for the BSE quoted above are stated in terms of the local time
(ie GMT+530) in Mumbai India
BSElsquos normal trading sessions are on all days of the week except Saturdays Sundays
and Holidays declared by the Exchange in advance 36
283 Services of BSE
BSE also had a wide range of services to empower investors and facilitate smooth
transactions These services are as follows
2831 Investor Services
The Dept of investor services redresses grievances of investors BSE was the first
exchange in the country to provide an amount of Rs 1 million towards the investor
36 Asia Technical Analysis with Phil Smith wwwreutersindianet
41
protection fund it is an amount higher than that of any exchange in the country BSE
launched a nationwide investor awareness program ―Safe Investing in the Stock
Market under which 264 programmers were held in more than 200 cities
2832 The BSE Online Trading (BOLT)
BSE on line Trading (BOLT) facilities on-line screen based trading in securities
BOLT is currently operating in 25000 trader work stations located across over 399
cities in India
2833 BSEWEBXcom
In February 2001 BSE introduced the worldlsquos first centralized exchange based
Internet trading system BSEWEBXcom This initiative enables investors anywhere
in the world to trade on BSE platform
2834 Surveillance
BSElsquos Online Surveillance System (BOSS) monitors on a real time basis the price
movements volume position and real time measurements of the default risk market
reconstruct and generation of cross market alerts
2835 BSE Training Institute
BTI imparts capital market training and certification in collaboration with reputed
management institutes and universities It offers over 40 courses on various aspects of
the capital mark and financial sector More than 20000 people have attended the BTI
program
284 Awards
Fowling awards were given to BSE
The world council of Corporate Governance has awarded the Golden Peacock
Global CSR Award for BSElsquos initiatives in corporate social responsibility
The Annual Reports and Accounts of BSE for the year ended March 312006 and
42
March 312007 have been awarded the ICAI awards for excellence in financial
reporting
The Human Resource Management at BSE has won the Asia-Pacific HRM awards
for its efforts in employer branding through talent management at work health
management at work and excellence in HR through technology
Drawing from its rich past and its equally robust performance in the recent times
BSE will continue to remain an icon in the Indian Capital Market
285 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 days closing price is taken for computation of Index closure
The use of Index Closure Algorithm prevents any intentional manipulation of the
closing index value
286 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 affect the
index values The BSE Index Cell does the day-to-day maintenance of the index
within the broad index policy framework set by the BSE Index Committee The BSE
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 BSE Index Committee comprises
of capital market expert fund managers market participants and members of the BSE
Governing Board
43
287 On-Line Computation of the Index
During trading hours value of the Index is calculated and disseminated on real time
basis This is done automatically on the basis of prices at which trades in Index
constituents are executed
288 Adjustment for Bonus Rights and Newly Issued Capital
SENSEX calculation needs to be adjusted for issue of Bonus or 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 BSE Index Cell the base value is adjusted which is used to alter
market capitalization of the component stocks to arrive at the SENSEX value The
BSE Index Cell keeps a close watch on the events that might affect the index on a
regular basis and carries out daily maintenance of all the 19 Indices
2881 Adjustments for Rights Issues
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 (ex-right) price An offsetting or
proportionate adjustment is then made to the Base Market capitalization
2882 Adjustments for Bonus Issue
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
2883 Other Issues 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
buy-back of shares corporate restructuring etc
44
289 Listing Categories
Before badla was resumed in 1996 there were only two categories of securities listed
on the BSE the specified group of shares comprising The securities in which carry
forward deals were allowed and the cash group shares in which no carry forward deals
were permitted Later it was observed that the facility of carry forward was not being
used in all the 94 scrips in the specified group Hence after badla was resumed the
size of the specified group was reduced to 32 scrips on 3 April 1996 The BSE later
decided to regroup the existing A and B group shares into three categories The BSE
delisted 637 companies for a period of 3 years during 2004-05 for non-compliance of
listing agreements
A Group This group consists of large stock with turnover and high floating stock
with large market capitalization In other words scrips with more liquidity and high
networth are included in this group At present there are 150 scrips in this group
B1 Group This group includes scrips of quality companies with equity above Rs 3
crore with high growth potential and trading frequency No carry forward facility was
allowed in this group in June 2000 there were 1803 scrips in this group
B2 Group Scrips in this group were just like those of B1 but with fortnightly
settlement However in September 1996 the BSE introduced weekly settlement for all
scrips listed on the exchange thus doing away with the distinction between the B1 and
B2 groups On June 2000 there were 3219 scrips in this group
Z Group Subsequently a Z group was introduced in 1999 with scrips of companies
that do not meet the rules regulations and stipulations laid down by the exchange It
is a buyer beware company These are some 300 scrips in the group All Z category
stocks result in delivers
F Group A new Flsquo group pertaining to debt market segment was started with effect
from 9 September 1996
S Group The BSE reduced post-public issue capital base requirement from Rs10
crore to Rs3 crore to attract listing by companies with a smaller capital base It also
45
started a new trading segment small cap stock segment known as the Slsquo segment
Corporate with minimum turnover of an equal amount would be eligible to list scrips
on this segment In addition stocks listed on the regional exchanges would also be
able to list on the lsquoSlsquo segment subject to meeting certain criteria
2810 Base Market capitalization Adjustment
The formula for adjusting the Base Market capitalization is as follows
New Base Market Capitalization (NBMC)
New Market capitalization
NBMC = Old Base Market capitalization x mdashmdashmdashmdashmdashmdashmdashmdashmdashmdashmdash
Old Market capitalization
To illustrate suppose a company issues right shares which increases the market
capitalization of the shares of that company by say Rs100 crores The existing Base
Market capitalization (Old Base Market capitalization) say is Rs2450 crores and the
aggregate market capitalization of all the shares included in the index before the right
issue is made is say Rs4781 crore The New Base Market capitalization will then
be
2450x (4781+100)
_____________________ = Rs250124 crores
4781
This figure of Rs 250124 crore will be used as the Base Market capitalization for
calculating the index number from then onwards till the next base change becomes
necessary
Index Review Frequency
The BSE 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
29 STOCK MARKET INDEX
The stock market index is the most important indices of all as it measures overall
market sentiment through a set of stocks that representative of the market The stock
46
market index is a barometer of the market behavior It reflects direction and indicates
day-to-day fluctuations in stock prices The market index reflects expectations about
the behavior of the economy as a whole It is a precursor of economic cycles The
function of a stock index is to provide investors with information regarding the
average share price in the market An ideal index must represent changes in the prices
of the scrips and reflect price movements of typical shares for better market
representation Stock index is a barometer of a nationlsquos economic health as market
prices reflect expectations about the economylsquos performance Stock indices termed as
leading economic as they indicate what is going to happen in the economy in the
future The returns generated in the stock market are based on future expectations A
good market index incorporates a set of scrips which have high market capitalization
and high liquidity Market capitalization is the sum of the market value of all the
stocks included in the index The market value is derived by multiplying the price of
the share outstanding In other words the bid-ask spread is minimum The index on a
day is calculated as the percentage of the aggregate market value of the set of scrips
incorporated in the index on that day to the average market value of the same scrips
during the base period
291 Definition of an Index
A price index is such as the stock market price of the individual securities in the
market It reflects the overall price or return movements of a group of securities
Movements in an index are determined by sample weighting and computational
procedure Sample is normally generated by random selection or try a non random
selection technique designed to incorporate desired characteristics are used to select
sample shares rather than by completely random selection Major criteria for selection
are market activity due representation to various industrial groups and to major stock
exchanges
292 Global Stock Market Indices
2921 The Dow Jones Industrial averagersquos
It is the most widely watched and quoted index because of its long existence The
Dow has 30 constituents and it follows the methodology of price based weighted
47
Changes to stocks included in the Dow are infrequent three stocks were
addeddropped in 1991 four in 1997 and four in 1999 The addition of Microsoft and
Intel in 1999 was the first inclusion of Nasdaq market stocks to the Dow 30
2922 The Nasdaq composite index
The index is the market capitalization weighted of prices for all the stocks listed in the
Nasdaq stock market The Nasdaq composite began on 8 February 1971 with a base
of 100
2923 The Nasdaq 100 index
Nasdaq 100 comprises the largest computer software and telecom stocks by market
capitalization on the Nasdaq For a company to be included in the Nasdaq 100 it must
have a minimum average trading volume of 100000 shares per day and must have
been trading on a major exchange for at least a year or two
2924 The S amp P 500 index
This index comprises 500 biggest publicly traded companies in the US by market
capitalization Most money managers treat the S amp P 500 as a proxy for the US stock
market The S amp P 500 tries to cover all major areas of US economy To be included a
company must be profitable the prospective company must not be closely hold and
must have a large trading volume for its shares
2925 The FTSE 100
The FTSE 100 consists of the largest 100 companies by full market Value listed on
the London Stock Exchange The FTSE 100 is the benchmark index to indicate the
performance of the European market It is a market capitalization weighted index that
also considers the free float weighted of individual stocks before including them in
the index
2926 The MSCI Indices
Include the MSCIEAFE (Europe Australia and Far East) MSCI Europe MSCI
world MSCI (EMF) and MSCI Pacific Basin Indices
48
The MSCI world Index is a free float adjusted market capitalization index that is
designed to measure global developed market equity performance As of April 2002
the MSCI world Index consisted of the MSCI world Index consisted of the following
23 developed market country indices
Australia Austria Belgium Canada Denmark Finland France Germany Greece
Hong Kong Ireland Italy Japan Netherlands New Zealand Norway Singapore
Portugal Spain Sweden Switzerland United Kingdom and the United States of
America
293 Methodology for Calculating The Index
2931 Price Weighted Index
In this method the price of each stock in the index is summed up which is then
equated to an index starting value An arbitrary date is set as the base and the
Laspeyerlsquos Price Index which measures price changes against a fixed base period
quantity weight is used In case of a stock split the market price of the stock falls and
these results in less weighted in the index The Dow Jones Industrial Average and
Nikkie 225 are price-weighted indices
2932 Equal Weighting
In this method each stocklsquos percentage weight in the index is equal and hence all
stocks have an equal influence on the index movement The value line index at
Kansas City Board of Trade (KCBT) is an equal weighted index
2933 Market Capitalization Weighted
29331 Full Market Capitalization Method
In this method the number of shares outstanding multiplied by the market price of a
companylsquos share determines the scriplsquos weighted in the index The shares with the
highest market capitalization would have a higher weighted and would be most
influential in this type of index Eg S amp P 500 Index in USA and S amp P CNX Nify in
India
49
29332 Modified Capitalization Weighted
This method seeks to limit the influence of the largest stocks in the index which
otherwise would dominate the entire index This method sets a limit on the largest
stock or a group of stocks The NASDAQ 100 Index is calculated by using this
method
294 Free Float Market Capitalization Method
2941 Concept
Free float methodology refers to an index construction methodology that takes in to
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 Strategic holding government 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
All BSE indices with exception of BSE-PSU index have adopted the free-float
methodology
2942 Definition of Free Float
Share holding of investor that would not in the normal course come into the
open market for trading are treated as ―Controlling Strategic Holding and
hence not included in free float specifically the following categories of
holding are generally excluded from the definition of free float
Shares hold by foundersdirectorsacquires which has control element
Shares held by person with ―Controlling Interestlsquo
Shares held by Govt as promoters
50
Holding through the FDI Route
Strategic Stakes by private corporate bodiesindividuals
Equity held by employee welfare trusts
Locked-in-shares and shares which not be sold in the open market in normal
course
2943 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-agrave-Vis an investible
index This enables an apple-to-apple comparison thereby facilitating better
evaluation of performance of active managers
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 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
The free float methodology of index construction is considered to be an industry best
practice and all major index providers like MSCI FTSE SampP 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
51
29441 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 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 055 means that only 55 of the market
capitalization of the company will be considered for index calculation
Table 24 Free-float Bands
Free-Float Free-Float Factor Free-Float Free-Float Factor
gt0 - 5 005 gt50 - 55 055
gt5 - 10 010 gt55 - 60 060
gt10 - 15 015 gt60 - 65 065
gt15 - 20 020 gt65 - 70 070
gt20 - 25 025 gt70 - 75 075
gt25 - 30 030 gt75 - 80 080
gt30 - 35 035 gt80 - 85 085
gt35 - 40 040 gt85 - 90 090
gt40 - 45 045 gt90 - 95 095
gt45 - 50 050 gt95 - 100 100
Source wwwbseindiacom
295 BSE Indices
For the premier stock exchange that pioneered the securities transaction business
in India over a century of experience is a proud achievement A lot has changed since
1875 when 318 persons by paying a then princely amount of Re 1 became members
of what today is called Bombay Stock Exchange Limited (BSE) Over the decades
the stock market in the country has passed through good and bad periods The journey
52
in the 20th century has not been an easy one Till the decade of eighties there was no
measure or scale that could precisely measure the various ups and downs in the Indian
stock market BSE in 1986 came out with a Stock Index-SENSEX- that subsequently
became the barometer of the Indian stock market
The launch of SENSEX in 1986 was later followed up in January 1989 by
introduction of BSE National Index (Base 1983-84 = 100) It comprised 100 stocks
listed at five major stock exchanges in India - Mumbai Calcutta Delhi Ahmadabad
and Madras The BSE National Index was renamed BSE-100 Index from October 14
1996 and since then it is being calculated taking into consideration only the prices of
stocks listed at BSE BSE launched the dollar-linked version of BSE-100 index on
May 22 2006
With a view to provide a better representation of the increasing number of listed
companies larger market capitalization and the new industry sectors BSE launched
on 27th May 1994 two new index series viz the BSE-200 and the DOLLEX-200
Since then BSE has come a long way in attuning itself to the varied needs of
investors and market participants In order to fulfill the need for still broader
segment-specific and sector-specific indices BSE has continuously been increasing
the range of its indices BSE-500 Index and 5 sectorial indices were launched in 1999
In 2001 BSE launched BSE-PSU Index DOLLEX-30 and the countrys first free-
float based index - the BSE TEC Index Over the years BSE shifted all its indices to
the free-float methodology
BSE disseminates information on the Price-Earnings Ratio the Price to Book Value
Ratio and the Dividend Yield Percentage on day-to-day basis of all its major indices
The values of all BSE indices are updated on real time basis during market hours and
displayed through the BOLT system BSE website and news wire agencies
All BSE Indices are reviewed periodically by the BSE Index Committee This
Committee which comprises eminent independent finance professionals frames the
broad policy guidelines for the development and maintenance of all BSE indices The
BSE Index Cell carries out the day-to-day maintenance of all indices and conducts
research on development of new indices
53
2951 BSE-100 Index
A broad-based index the BSE-100 was formerly known as the BSE National index
This Index has 1983-84 as the base year and was launched in 1989 In line with the
shift of the BSE Indices to the globally accepted Free-Float methodology BSE-100
was shifted to Free-Float methodology effective from April 5 2004 The method of
computation of Free-Float index and determination of free-float factors is similar to
the methodology for SENSEX
Table 25 Index Specification
Base Year 1983-84
Base Index Value 100
Date of Launch 3-Jan-89
Method of calculation Launched on full market capitalization
method and effective April 05 2004
calculation method shifted to free-float
market capitalization
Number of scrips 100
Index calculation frequency Real Time
Source wwwbseindiacom
2952 Base Year
The financial year 1983-84 has been chosen as the base year The price stability
during that year and proximity to the index series were the main consideration for
choice of 1983-84 as the base year The base value was fixed at 100 points
2953 Dollex-100
BSE also calculates a dollar-linked version of SENSEX and historical values of this
index are available since its inception
2954 BSE-100 index - Scrip Selection Criteria
The general guidelines for selection of constituents in BSE-100 are as follows
Trading Frequency The scrip should have been traded on 95 of the trading days
54
in the last three months Exceptions can be made for extreme reasons like scrip
suspension etc
Final Rank The scrip should figure in the top 200 companies listed by final rank
The final rank is arrived at by assigning 75 weighted to the rank on the basis of
three-month average full market capitalization and 25 weighted to the liquidity rank
based on three-month average daily turnover amp three-month average impact cost
IndustrySector Representation Scrip selection would generally take into account a
balanced sectorial representation of the listed companies in the universe of BSE
Track Record In the opinion of the BSE Index Committee the company should
have an acceptable track record
210 STOCK MARKET VOLATILITY
2101 Meaning
Volatility is a measure for variation of price of a financial instrument over time
Historic volatility is derived from time series of past market prices An implied
volatility is derived from the market price of a market traded derivative (in particular
an option) Volatility does not measure the direction of price changes merely their
dispersion This is because when calculating standard deviation (or variance) all
differences are squared so that negative and positive differences are combined into
one quantity Two instruments with different volatilities may have the same expected
return but the instrument with higher volatility will have larger swings in values over
a given period of time
For example a lower volatility stock may have an expected (average) return of 7
with annual volatility of 5 This would indicate returns from approximately negative
3 to positive 17 most of the time (19 times out of 20 or 95 via a two standard
deviation rule) A higher volatility stock with the same expected return of 7 but
with annual volatility of 20 would indicate returns from approximately negative
33 to positive 47 most of the time (19 times out of 20 or 95) These estimates
assume a normal distribution in reality stocks are found to be leptokurtotic
55
2102 Terminology used in volatility
Volatility as described here refers to the actual current volatility of a financial
instrument for a specified period (for example 30 days or 90 days) It is the volatility
of a financial instrument based on historical prices over the specified period with the
last observation the most recent price This phrase is used particularly when it is
wished to distinguish between the actual current volatility of an instrument and
actual historical volatility which refers to the volatility of a financial instrument
over a specified period but with the last observation on a date in the past
actual future volatility which refers to the volatility of a financial instrument
over a specified period starting at the current time and ending at a future date
(normally the expiry date of an options)
historical implied volatility which refers to the implied volatility observed from
historical prices of the financial instrument (normally options)
current implied volatility which refers to the implied volatility observed from
current prices of the financial instrument
future implied volatility which refers to the implied volatility observed from
future prices of the financial instrument
For a financial instrument whose price follows a random walk or wiener process the
width of the distribution increases as time increases This is because there is an
increasing profitability that the instruments price will be farther away from the initial
price as time increases However rather than increase linearly the volatility increases
with the square-root of time as time increases because some fluctuations are expected
to cancel each other out so the most likely deviation after twice the time will not be
twice the distance from zero
2103 Usefulness of volatility for Investors
Investors care about volatility for five reasons
1 The wider the swings in an investments price the harder emotionally it is to
not worry
2 Price volatility of a trading instrument can define position sizing in a portfolio
56
3 When certain cash flows from selling a security are needed at a specific future
date higher volatility means a greater chance of a shortfall
4 Higher volatility of returns while saving for retirement results in a wider
distribution of possible final portfolio values
5 Higher volatility of return when retired gives withdrawals a larger permanent
impact on the portfolios value
6 Price volatility presents opportunities to buy assets cheaply and sell when
overpriced
37
Committee the National Stock Exchange was incorporated in 1992 by Industrial
Development Bank of India Industrial Credit and Investment Corporation of India
Industrial Finance Corporation of India all Insurance Corporations selected
commercial banks and others
2771 NSE provides exposure to investors in two types of markets
namely
Wholesale debt market
Capital market
Wholesale Debt Market - Similar to money market operations debt market
operations involve institutional investors and corporate bodies entering into
transactions of high value in financial instruments like treasury bills government
securities commercial papers etc
Capital market- A capital market is a market for securities (debt or equity) where
business enterprises and governments can raise long term funds It is defined as a
market in which money is defined as a market in which money is provided for periods
longer than a year34 as the raising of short term funds takes place on other markets
Capital markets may be classified as primary markets and secondary markets In
primary markets new stock or bond issues are sold to investors via a mechanism
known as underwriting In the secondary markets existing securities are sold and
bought among investors or traders usually on a securities exchange over the counter
or elsewhere
278 Trading at NSE amp BSE
Fully automated screen-based trading mechanism
Strictly follows the principle of an order-driven market
Trading members are linked through a communication network
34 Steven M Sheffrin (2003) Economics Principles in action Upper Saddle River Pearson Prentice
Hall
38
This network allows them to execute trade from their offices
The prices at which the buyer and seller are willing to transact will appear on
the screen
When the prices match the transaction will be completed
A confirmation slip will be printed at the office of the trading member
2781 Advantages of trading at NSE amp BSE
Integrated network for trading in stock market of India
Fully automated screen based system that provides higher degree of
transparency
Investors can transact from any part of the country at uniform prices
Greater functional efficiency supported by totally computerized network
28 THE BOMBAY STOCK EXCHANGE
Formerly the Stock Exchange Mumbai popularly called Bombay Stock Exchange
or BSE is the oldest stock exchange in Asia and has the greatest number of listed
companies in the world with 4700 listed as of August 2007 35
It is located at Dalal Street Mumbai India On 31 December 2007 the equity market
capitalization of the BSE was US $ 179 trillion making it the largest stock exchange
in South Asia and the 12th largest in the world
With over 4700 Indian companies list on the stock exchange [10]
and it has a
significant trading volume The BSE SENSEX (SENSITIVE INDEX) also called the
―BSE 30 is a widely used market index in India and Asia Though many other
exchanges exist BSE and the National Stock Exchange of India account for most of
the trading in shares in India
35 World Federation of Exchanges (2007) wwwworld-exchangesorg
39
281 History of the Bombay Stock exchange
Trading in securities has been in vogue in India for a little over 200 years Trading in
securities dates back 1793 most of them being transactions in loan securities of the
East India Company The broking community prospered as there was a rise in prices
which led to a share mania during 1861-65 This bubble burst in 1865 when the
American Civil War ended The brokers realized that investor confidence in the
securities market could be sustained only by organizing themselves into a regulated
body with defined rules and regulations The realization resulted in formation of ―The
Native Share and Stock Brokerslsquo Association which later came to be known as the
Bombay Stock Exchange In 1875 these brokers assembled at a place now called
Dalal Street
The Bombay Stock Exchange is a voluntary nonprofit making association of broker
members It emerged as a premier stock exchange after the 1960 The increased pace
of industrialization caused by the two world wars protection to the domestic industry
and the governmentlsquos fiscal policies aided the growth of new issues which in turn
helped the BSE to prosper The BSE dominated the Indian Capital Market by
accounting for more than 60 per cent of the all Indian turn over
Until 1992 the BSE operated like a closed club of selected members With the
securities scam outburst in 1992 and the SEBI taking over the rains of the Stock
Market the BSE had to bring about changes in its operational policies Until March
1995 the BSE had an open outcry system of trading However when faced with stiff
competition from NSE the countrylsquos first modern computerized and professionally
managed stock exchange set up in 1994 the BSE had to change its system of trading
and operation
On 14 March 1995 the BSE turned to electronic trading whereby brokers trade using
computers This system is known as the BSE On-line Trading System (BOLT)
The introduction of BOLT helped in improving trading volumes significantly
reducing the spread between buy and sell orders better trading in odd lot shares fixed
income instruments and dealings in the renunciation of rights shares
40
In 1995 BOLT was limited to Mumbai whereas the NSE was operating at the
national level As a result the BSE submitted a proposal for allowing installation of
terminals connected to BOLT in centers outside Mumbai After rejecting the proposal
four times on 29 october 1996 the SEBI finally allowed the BSE to use its BOLT
system nationwide Later the BSE set up a central depository system to dematerialize
shares and promote demate Account (trading)
282 Hours of Operation
Beginning of the Day Session 800 to 900
Trading Session 900 to 1530
Position Transfer Session 1530 to 1550
Closing Session 1550 to 1605
Option Exercise Session 1605 to 1635
Margin Session 1635 to 1650
Query Session 1650 to1735
End of Day Session 1735
The hours of operation for the BSE quoted above are stated in terms of the local time
(ie GMT+530) in Mumbai India
BSElsquos normal trading sessions are on all days of the week except Saturdays Sundays
and Holidays declared by the Exchange in advance 36
283 Services of BSE
BSE also had a wide range of services to empower investors and facilitate smooth
transactions These services are as follows
2831 Investor Services
The Dept of investor services redresses grievances of investors BSE was the first
exchange in the country to provide an amount of Rs 1 million towards the investor
36 Asia Technical Analysis with Phil Smith wwwreutersindianet
41
protection fund it is an amount higher than that of any exchange in the country BSE
launched a nationwide investor awareness program ―Safe Investing in the Stock
Market under which 264 programmers were held in more than 200 cities
2832 The BSE Online Trading (BOLT)
BSE on line Trading (BOLT) facilities on-line screen based trading in securities
BOLT is currently operating in 25000 trader work stations located across over 399
cities in India
2833 BSEWEBXcom
In February 2001 BSE introduced the worldlsquos first centralized exchange based
Internet trading system BSEWEBXcom This initiative enables investors anywhere
in the world to trade on BSE platform
2834 Surveillance
BSElsquos Online Surveillance System (BOSS) monitors on a real time basis the price
movements volume position and real time measurements of the default risk market
reconstruct and generation of cross market alerts
2835 BSE Training Institute
BTI imparts capital market training and certification in collaboration with reputed
management institutes and universities It offers over 40 courses on various aspects of
the capital mark and financial sector More than 20000 people have attended the BTI
program
284 Awards
Fowling awards were given to BSE
The world council of Corporate Governance has awarded the Golden Peacock
Global CSR Award for BSElsquos initiatives in corporate social responsibility
The Annual Reports and Accounts of BSE for the year ended March 312006 and
42
March 312007 have been awarded the ICAI awards for excellence in financial
reporting
The Human Resource Management at BSE has won the Asia-Pacific HRM awards
for its efforts in employer branding through talent management at work health
management at work and excellence in HR through technology
Drawing from its rich past and its equally robust performance in the recent times
BSE will continue to remain an icon in the Indian Capital Market
285 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 days closing price is taken for computation of Index closure
The use of Index Closure Algorithm prevents any intentional manipulation of the
closing index value
286 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 affect the
index values The BSE Index Cell does the day-to-day maintenance of the index
within the broad index policy framework set by the BSE Index Committee The BSE
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 BSE Index Committee comprises
of capital market expert fund managers market participants and members of the BSE
Governing Board
43
287 On-Line Computation of the Index
During trading hours value of the Index is calculated and disseminated on real time
basis This is done automatically on the basis of prices at which trades in Index
constituents are executed
288 Adjustment for Bonus Rights and Newly Issued Capital
SENSEX calculation needs to be adjusted for issue of Bonus or 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 BSE Index Cell the base value is adjusted which is used to alter
market capitalization of the component stocks to arrive at the SENSEX value The
BSE Index Cell keeps a close watch on the events that might affect the index on a
regular basis and carries out daily maintenance of all the 19 Indices
2881 Adjustments for Rights Issues
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 (ex-right) price An offsetting or
proportionate adjustment is then made to the Base Market capitalization
2882 Adjustments for Bonus Issue
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
2883 Other Issues 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
buy-back of shares corporate restructuring etc
44
289 Listing Categories
Before badla was resumed in 1996 there were only two categories of securities listed
on the BSE the specified group of shares comprising The securities in which carry
forward deals were allowed and the cash group shares in which no carry forward deals
were permitted Later it was observed that the facility of carry forward was not being
used in all the 94 scrips in the specified group Hence after badla was resumed the
size of the specified group was reduced to 32 scrips on 3 April 1996 The BSE later
decided to regroup the existing A and B group shares into three categories The BSE
delisted 637 companies for a period of 3 years during 2004-05 for non-compliance of
listing agreements
A Group This group consists of large stock with turnover and high floating stock
with large market capitalization In other words scrips with more liquidity and high
networth are included in this group At present there are 150 scrips in this group
B1 Group This group includes scrips of quality companies with equity above Rs 3
crore with high growth potential and trading frequency No carry forward facility was
allowed in this group in June 2000 there were 1803 scrips in this group
B2 Group Scrips in this group were just like those of B1 but with fortnightly
settlement However in September 1996 the BSE introduced weekly settlement for all
scrips listed on the exchange thus doing away with the distinction between the B1 and
B2 groups On June 2000 there were 3219 scrips in this group
Z Group Subsequently a Z group was introduced in 1999 with scrips of companies
that do not meet the rules regulations and stipulations laid down by the exchange It
is a buyer beware company These are some 300 scrips in the group All Z category
stocks result in delivers
F Group A new Flsquo group pertaining to debt market segment was started with effect
from 9 September 1996
S Group The BSE reduced post-public issue capital base requirement from Rs10
crore to Rs3 crore to attract listing by companies with a smaller capital base It also
45
started a new trading segment small cap stock segment known as the Slsquo segment
Corporate with minimum turnover of an equal amount would be eligible to list scrips
on this segment In addition stocks listed on the regional exchanges would also be
able to list on the lsquoSlsquo segment subject to meeting certain criteria
2810 Base Market capitalization Adjustment
The formula for adjusting the Base Market capitalization is as follows
New Base Market Capitalization (NBMC)
New Market capitalization
NBMC = Old Base Market capitalization x mdashmdashmdashmdashmdashmdashmdashmdashmdashmdashmdash
Old Market capitalization
To illustrate suppose a company issues right shares which increases the market
capitalization of the shares of that company by say Rs100 crores The existing Base
Market capitalization (Old Base Market capitalization) say is Rs2450 crores and the
aggregate market capitalization of all the shares included in the index before the right
issue is made is say Rs4781 crore The New Base Market capitalization will then
be
2450x (4781+100)
_____________________ = Rs250124 crores
4781
This figure of Rs 250124 crore will be used as the Base Market capitalization for
calculating the index number from then onwards till the next base change becomes
necessary
Index Review Frequency
The BSE 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
29 STOCK MARKET INDEX
The stock market index is the most important indices of all as it measures overall
market sentiment through a set of stocks that representative of the market The stock
46
market index is a barometer of the market behavior It reflects direction and indicates
day-to-day fluctuations in stock prices The market index reflects expectations about
the behavior of the economy as a whole It is a precursor of economic cycles The
function of a stock index is to provide investors with information regarding the
average share price in the market An ideal index must represent changes in the prices
of the scrips and reflect price movements of typical shares for better market
representation Stock index is a barometer of a nationlsquos economic health as market
prices reflect expectations about the economylsquos performance Stock indices termed as
leading economic as they indicate what is going to happen in the economy in the
future The returns generated in the stock market are based on future expectations A
good market index incorporates a set of scrips which have high market capitalization
and high liquidity Market capitalization is the sum of the market value of all the
stocks included in the index The market value is derived by multiplying the price of
the share outstanding In other words the bid-ask spread is minimum The index on a
day is calculated as the percentage of the aggregate market value of the set of scrips
incorporated in the index on that day to the average market value of the same scrips
during the base period
291 Definition of an Index
A price index is such as the stock market price of the individual securities in the
market It reflects the overall price or return movements of a group of securities
Movements in an index are determined by sample weighting and computational
procedure Sample is normally generated by random selection or try a non random
selection technique designed to incorporate desired characteristics are used to select
sample shares rather than by completely random selection Major criteria for selection
are market activity due representation to various industrial groups and to major stock
exchanges
292 Global Stock Market Indices
2921 The Dow Jones Industrial averagersquos
It is the most widely watched and quoted index because of its long existence The
Dow has 30 constituents and it follows the methodology of price based weighted
47
Changes to stocks included in the Dow are infrequent three stocks were
addeddropped in 1991 four in 1997 and four in 1999 The addition of Microsoft and
Intel in 1999 was the first inclusion of Nasdaq market stocks to the Dow 30
2922 The Nasdaq composite index
The index is the market capitalization weighted of prices for all the stocks listed in the
Nasdaq stock market The Nasdaq composite began on 8 February 1971 with a base
of 100
2923 The Nasdaq 100 index
Nasdaq 100 comprises the largest computer software and telecom stocks by market
capitalization on the Nasdaq For a company to be included in the Nasdaq 100 it must
have a minimum average trading volume of 100000 shares per day and must have
been trading on a major exchange for at least a year or two
2924 The S amp P 500 index
This index comprises 500 biggest publicly traded companies in the US by market
capitalization Most money managers treat the S amp P 500 as a proxy for the US stock
market The S amp P 500 tries to cover all major areas of US economy To be included a
company must be profitable the prospective company must not be closely hold and
must have a large trading volume for its shares
2925 The FTSE 100
The FTSE 100 consists of the largest 100 companies by full market Value listed on
the London Stock Exchange The FTSE 100 is the benchmark index to indicate the
performance of the European market It is a market capitalization weighted index that
also considers the free float weighted of individual stocks before including them in
the index
2926 The MSCI Indices
Include the MSCIEAFE (Europe Australia and Far East) MSCI Europe MSCI
world MSCI (EMF) and MSCI Pacific Basin Indices
48
The MSCI world Index is a free float adjusted market capitalization index that is
designed to measure global developed market equity performance As of April 2002
the MSCI world Index consisted of the MSCI world Index consisted of the following
23 developed market country indices
Australia Austria Belgium Canada Denmark Finland France Germany Greece
Hong Kong Ireland Italy Japan Netherlands New Zealand Norway Singapore
Portugal Spain Sweden Switzerland United Kingdom and the United States of
America
293 Methodology for Calculating The Index
2931 Price Weighted Index
In this method the price of each stock in the index is summed up which is then
equated to an index starting value An arbitrary date is set as the base and the
Laspeyerlsquos Price Index which measures price changes against a fixed base period
quantity weight is used In case of a stock split the market price of the stock falls and
these results in less weighted in the index The Dow Jones Industrial Average and
Nikkie 225 are price-weighted indices
2932 Equal Weighting
In this method each stocklsquos percentage weight in the index is equal and hence all
stocks have an equal influence on the index movement The value line index at
Kansas City Board of Trade (KCBT) is an equal weighted index
2933 Market Capitalization Weighted
29331 Full Market Capitalization Method
In this method the number of shares outstanding multiplied by the market price of a
companylsquos share determines the scriplsquos weighted in the index The shares with the
highest market capitalization would have a higher weighted and would be most
influential in this type of index Eg S amp P 500 Index in USA and S amp P CNX Nify in
India
49
29332 Modified Capitalization Weighted
This method seeks to limit the influence of the largest stocks in the index which
otherwise would dominate the entire index This method sets a limit on the largest
stock or a group of stocks The NASDAQ 100 Index is calculated by using this
method
294 Free Float Market Capitalization Method
2941 Concept
Free float methodology refers to an index construction methodology that takes in to
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 Strategic holding government 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
All BSE indices with exception of BSE-PSU index have adopted the free-float
methodology
2942 Definition of Free Float
Share holding of investor that would not in the normal course come into the
open market for trading are treated as ―Controlling Strategic Holding and
hence not included in free float specifically the following categories of
holding are generally excluded from the definition of free float
Shares hold by foundersdirectorsacquires which has control element
Shares held by person with ―Controlling Interestlsquo
Shares held by Govt as promoters
50
Holding through the FDI Route
Strategic Stakes by private corporate bodiesindividuals
Equity held by employee welfare trusts
Locked-in-shares and shares which not be sold in the open market in normal
course
2943 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-agrave-Vis an investible
index This enables an apple-to-apple comparison thereby facilitating better
evaluation of performance of active managers
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 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
The free float methodology of index construction is considered to be an industry best
practice and all major index providers like MSCI FTSE SampP 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
51
29441 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 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 055 means that only 55 of the market
capitalization of the company will be considered for index calculation
Table 24 Free-float Bands
Free-Float Free-Float Factor Free-Float Free-Float Factor
gt0 - 5 005 gt50 - 55 055
gt5 - 10 010 gt55 - 60 060
gt10 - 15 015 gt60 - 65 065
gt15 - 20 020 gt65 - 70 070
gt20 - 25 025 gt70 - 75 075
gt25 - 30 030 gt75 - 80 080
gt30 - 35 035 gt80 - 85 085
gt35 - 40 040 gt85 - 90 090
gt40 - 45 045 gt90 - 95 095
gt45 - 50 050 gt95 - 100 100
Source wwwbseindiacom
295 BSE Indices
For the premier stock exchange that pioneered the securities transaction business
in India over a century of experience is a proud achievement A lot has changed since
1875 when 318 persons by paying a then princely amount of Re 1 became members
of what today is called Bombay Stock Exchange Limited (BSE) Over the decades
the stock market in the country has passed through good and bad periods The journey
52
in the 20th century has not been an easy one Till the decade of eighties there was no
measure or scale that could precisely measure the various ups and downs in the Indian
stock market BSE in 1986 came out with a Stock Index-SENSEX- that subsequently
became the barometer of the Indian stock market
The launch of SENSEX in 1986 was later followed up in January 1989 by
introduction of BSE National Index (Base 1983-84 = 100) It comprised 100 stocks
listed at five major stock exchanges in India - Mumbai Calcutta Delhi Ahmadabad
and Madras The BSE National Index was renamed BSE-100 Index from October 14
1996 and since then it is being calculated taking into consideration only the prices of
stocks listed at BSE BSE launched the dollar-linked version of BSE-100 index on
May 22 2006
With a view to provide a better representation of the increasing number of listed
companies larger market capitalization and the new industry sectors BSE launched
on 27th May 1994 two new index series viz the BSE-200 and the DOLLEX-200
Since then BSE has come a long way in attuning itself to the varied needs of
investors and market participants In order to fulfill the need for still broader
segment-specific and sector-specific indices BSE has continuously been increasing
the range of its indices BSE-500 Index and 5 sectorial indices were launched in 1999
In 2001 BSE launched BSE-PSU Index DOLLEX-30 and the countrys first free-
float based index - the BSE TEC Index Over the years BSE shifted all its indices to
the free-float methodology
BSE disseminates information on the Price-Earnings Ratio the Price to Book Value
Ratio and the Dividend Yield Percentage on day-to-day basis of all its major indices
The values of all BSE indices are updated on real time basis during market hours and
displayed through the BOLT system BSE website and news wire agencies
All BSE Indices are reviewed periodically by the BSE Index Committee This
Committee which comprises eminent independent finance professionals frames the
broad policy guidelines for the development and maintenance of all BSE indices The
BSE Index Cell carries out the day-to-day maintenance of all indices and conducts
research on development of new indices
53
2951 BSE-100 Index
A broad-based index the BSE-100 was formerly known as the BSE National index
This Index has 1983-84 as the base year and was launched in 1989 In line with the
shift of the BSE Indices to the globally accepted Free-Float methodology BSE-100
was shifted to Free-Float methodology effective from April 5 2004 The method of
computation of Free-Float index and determination of free-float factors is similar to
the methodology for SENSEX
Table 25 Index Specification
Base Year 1983-84
Base Index Value 100
Date of Launch 3-Jan-89
Method of calculation Launched on full market capitalization
method and effective April 05 2004
calculation method shifted to free-float
market capitalization
Number of scrips 100
Index calculation frequency Real Time
Source wwwbseindiacom
2952 Base Year
The financial year 1983-84 has been chosen as the base year The price stability
during that year and proximity to the index series were the main consideration for
choice of 1983-84 as the base year The base value was fixed at 100 points
2953 Dollex-100
BSE also calculates a dollar-linked version of SENSEX and historical values of this
index are available since its inception
2954 BSE-100 index - Scrip Selection Criteria
The general guidelines for selection of constituents in BSE-100 are as follows
Trading Frequency The scrip should have been traded on 95 of the trading days
54
in the last three months Exceptions can be made for extreme reasons like scrip
suspension etc
Final Rank The scrip should figure in the top 200 companies listed by final rank
The final rank is arrived at by assigning 75 weighted to the rank on the basis of
three-month average full market capitalization and 25 weighted to the liquidity rank
based on three-month average daily turnover amp three-month average impact cost
IndustrySector Representation Scrip selection would generally take into account a
balanced sectorial representation of the listed companies in the universe of BSE
Track Record In the opinion of the BSE Index Committee the company should
have an acceptable track record
210 STOCK MARKET VOLATILITY
2101 Meaning
Volatility is a measure for variation of price of a financial instrument over time
Historic volatility is derived from time series of past market prices An implied
volatility is derived from the market price of a market traded derivative (in particular
an option) Volatility does not measure the direction of price changes merely their
dispersion This is because when calculating standard deviation (or variance) all
differences are squared so that negative and positive differences are combined into
one quantity Two instruments with different volatilities may have the same expected
return but the instrument with higher volatility will have larger swings in values over
a given period of time
For example a lower volatility stock may have an expected (average) return of 7
with annual volatility of 5 This would indicate returns from approximately negative
3 to positive 17 most of the time (19 times out of 20 or 95 via a two standard
deviation rule) A higher volatility stock with the same expected return of 7 but
with annual volatility of 20 would indicate returns from approximately negative
33 to positive 47 most of the time (19 times out of 20 or 95) These estimates
assume a normal distribution in reality stocks are found to be leptokurtotic
55
2102 Terminology used in volatility
Volatility as described here refers to the actual current volatility of a financial
instrument for a specified period (for example 30 days or 90 days) It is the volatility
of a financial instrument based on historical prices over the specified period with the
last observation the most recent price This phrase is used particularly when it is
wished to distinguish between the actual current volatility of an instrument and
actual historical volatility which refers to the volatility of a financial instrument
over a specified period but with the last observation on a date in the past
actual future volatility which refers to the volatility of a financial instrument
over a specified period starting at the current time and ending at a future date
(normally the expiry date of an options)
historical implied volatility which refers to the implied volatility observed from
historical prices of the financial instrument (normally options)
current implied volatility which refers to the implied volatility observed from
current prices of the financial instrument
future implied volatility which refers to the implied volatility observed from
future prices of the financial instrument
For a financial instrument whose price follows a random walk or wiener process the
width of the distribution increases as time increases This is because there is an
increasing profitability that the instruments price will be farther away from the initial
price as time increases However rather than increase linearly the volatility increases
with the square-root of time as time increases because some fluctuations are expected
to cancel each other out so the most likely deviation after twice the time will not be
twice the distance from zero
2103 Usefulness of volatility for Investors
Investors care about volatility for five reasons
1 The wider the swings in an investments price the harder emotionally it is to
not worry
2 Price volatility of a trading instrument can define position sizing in a portfolio
56
3 When certain cash flows from selling a security are needed at a specific future
date higher volatility means a greater chance of a shortfall
4 Higher volatility of returns while saving for retirement results in a wider
distribution of possible final portfolio values
5 Higher volatility of return when retired gives withdrawals a larger permanent
impact on the portfolios value
6 Price volatility presents opportunities to buy assets cheaply and sell when
overpriced
38
This network allows them to execute trade from their offices
The prices at which the buyer and seller are willing to transact will appear on
the screen
When the prices match the transaction will be completed
A confirmation slip will be printed at the office of the trading member
2781 Advantages of trading at NSE amp BSE
Integrated network for trading in stock market of India
Fully automated screen based system that provides higher degree of
transparency
Investors can transact from any part of the country at uniform prices
Greater functional efficiency supported by totally computerized network
28 THE BOMBAY STOCK EXCHANGE
Formerly the Stock Exchange Mumbai popularly called Bombay Stock Exchange
or BSE is the oldest stock exchange in Asia and has the greatest number of listed
companies in the world with 4700 listed as of August 2007 35
It is located at Dalal Street Mumbai India On 31 December 2007 the equity market
capitalization of the BSE was US $ 179 trillion making it the largest stock exchange
in South Asia and the 12th largest in the world
With over 4700 Indian companies list on the stock exchange [10]
and it has a
significant trading volume The BSE SENSEX (SENSITIVE INDEX) also called the
―BSE 30 is a widely used market index in India and Asia Though many other
exchanges exist BSE and the National Stock Exchange of India account for most of
the trading in shares in India
35 World Federation of Exchanges (2007) wwwworld-exchangesorg
39
281 History of the Bombay Stock exchange
Trading in securities has been in vogue in India for a little over 200 years Trading in
securities dates back 1793 most of them being transactions in loan securities of the
East India Company The broking community prospered as there was a rise in prices
which led to a share mania during 1861-65 This bubble burst in 1865 when the
American Civil War ended The brokers realized that investor confidence in the
securities market could be sustained only by organizing themselves into a regulated
body with defined rules and regulations The realization resulted in formation of ―The
Native Share and Stock Brokerslsquo Association which later came to be known as the
Bombay Stock Exchange In 1875 these brokers assembled at a place now called
Dalal Street
The Bombay Stock Exchange is a voluntary nonprofit making association of broker
members It emerged as a premier stock exchange after the 1960 The increased pace
of industrialization caused by the two world wars protection to the domestic industry
and the governmentlsquos fiscal policies aided the growth of new issues which in turn
helped the BSE to prosper The BSE dominated the Indian Capital Market by
accounting for more than 60 per cent of the all Indian turn over
Until 1992 the BSE operated like a closed club of selected members With the
securities scam outburst in 1992 and the SEBI taking over the rains of the Stock
Market the BSE had to bring about changes in its operational policies Until March
1995 the BSE had an open outcry system of trading However when faced with stiff
competition from NSE the countrylsquos first modern computerized and professionally
managed stock exchange set up in 1994 the BSE had to change its system of trading
and operation
On 14 March 1995 the BSE turned to electronic trading whereby brokers trade using
computers This system is known as the BSE On-line Trading System (BOLT)
The introduction of BOLT helped in improving trading volumes significantly
reducing the spread between buy and sell orders better trading in odd lot shares fixed
income instruments and dealings in the renunciation of rights shares
40
In 1995 BOLT was limited to Mumbai whereas the NSE was operating at the
national level As a result the BSE submitted a proposal for allowing installation of
terminals connected to BOLT in centers outside Mumbai After rejecting the proposal
four times on 29 october 1996 the SEBI finally allowed the BSE to use its BOLT
system nationwide Later the BSE set up a central depository system to dematerialize
shares and promote demate Account (trading)
282 Hours of Operation
Beginning of the Day Session 800 to 900
Trading Session 900 to 1530
Position Transfer Session 1530 to 1550
Closing Session 1550 to 1605
Option Exercise Session 1605 to 1635
Margin Session 1635 to 1650
Query Session 1650 to1735
End of Day Session 1735
The hours of operation for the BSE quoted above are stated in terms of the local time
(ie GMT+530) in Mumbai India
BSElsquos normal trading sessions are on all days of the week except Saturdays Sundays
and Holidays declared by the Exchange in advance 36
283 Services of BSE
BSE also had a wide range of services to empower investors and facilitate smooth
transactions These services are as follows
2831 Investor Services
The Dept of investor services redresses grievances of investors BSE was the first
exchange in the country to provide an amount of Rs 1 million towards the investor
36 Asia Technical Analysis with Phil Smith wwwreutersindianet
41
protection fund it is an amount higher than that of any exchange in the country BSE
launched a nationwide investor awareness program ―Safe Investing in the Stock
Market under which 264 programmers were held in more than 200 cities
2832 The BSE Online Trading (BOLT)
BSE on line Trading (BOLT) facilities on-line screen based trading in securities
BOLT is currently operating in 25000 trader work stations located across over 399
cities in India
2833 BSEWEBXcom
In February 2001 BSE introduced the worldlsquos first centralized exchange based
Internet trading system BSEWEBXcom This initiative enables investors anywhere
in the world to trade on BSE platform
2834 Surveillance
BSElsquos Online Surveillance System (BOSS) monitors on a real time basis the price
movements volume position and real time measurements of the default risk market
reconstruct and generation of cross market alerts
2835 BSE Training Institute
BTI imparts capital market training and certification in collaboration with reputed
management institutes and universities It offers over 40 courses on various aspects of
the capital mark and financial sector More than 20000 people have attended the BTI
program
284 Awards
Fowling awards were given to BSE
The world council of Corporate Governance has awarded the Golden Peacock
Global CSR Award for BSElsquos initiatives in corporate social responsibility
The Annual Reports and Accounts of BSE for the year ended March 312006 and
42
March 312007 have been awarded the ICAI awards for excellence in financial
reporting
The Human Resource Management at BSE has won the Asia-Pacific HRM awards
for its efforts in employer branding through talent management at work health
management at work and excellence in HR through technology
Drawing from its rich past and its equally robust performance in the recent times
BSE will continue to remain an icon in the Indian Capital Market
285 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 days closing price is taken for computation of Index closure
The use of Index Closure Algorithm prevents any intentional manipulation of the
closing index value
286 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 affect the
index values The BSE Index Cell does the day-to-day maintenance of the index
within the broad index policy framework set by the BSE Index Committee The BSE
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 BSE Index Committee comprises
of capital market expert fund managers market participants and members of the BSE
Governing Board
43
287 On-Line Computation of the Index
During trading hours value of the Index is calculated and disseminated on real time
basis This is done automatically on the basis of prices at which trades in Index
constituents are executed
288 Adjustment for Bonus Rights and Newly Issued Capital
SENSEX calculation needs to be adjusted for issue of Bonus or 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 BSE Index Cell the base value is adjusted which is used to alter
market capitalization of the component stocks to arrive at the SENSEX value The
BSE Index Cell keeps a close watch on the events that might affect the index on a
regular basis and carries out daily maintenance of all the 19 Indices
2881 Adjustments for Rights Issues
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 (ex-right) price An offsetting or
proportionate adjustment is then made to the Base Market capitalization
2882 Adjustments for Bonus Issue
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
2883 Other Issues 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
buy-back of shares corporate restructuring etc
44
289 Listing Categories
Before badla was resumed in 1996 there were only two categories of securities listed
on the BSE the specified group of shares comprising The securities in which carry
forward deals were allowed and the cash group shares in which no carry forward deals
were permitted Later it was observed that the facility of carry forward was not being
used in all the 94 scrips in the specified group Hence after badla was resumed the
size of the specified group was reduced to 32 scrips on 3 April 1996 The BSE later
decided to regroup the existing A and B group shares into three categories The BSE
delisted 637 companies for a period of 3 years during 2004-05 for non-compliance of
listing agreements
A Group This group consists of large stock with turnover and high floating stock
with large market capitalization In other words scrips with more liquidity and high
networth are included in this group At present there are 150 scrips in this group
B1 Group This group includes scrips of quality companies with equity above Rs 3
crore with high growth potential and trading frequency No carry forward facility was
allowed in this group in June 2000 there were 1803 scrips in this group
B2 Group Scrips in this group were just like those of B1 but with fortnightly
settlement However in September 1996 the BSE introduced weekly settlement for all
scrips listed on the exchange thus doing away with the distinction between the B1 and
B2 groups On June 2000 there were 3219 scrips in this group
Z Group Subsequently a Z group was introduced in 1999 with scrips of companies
that do not meet the rules regulations and stipulations laid down by the exchange It
is a buyer beware company These are some 300 scrips in the group All Z category
stocks result in delivers
F Group A new Flsquo group pertaining to debt market segment was started with effect
from 9 September 1996
S Group The BSE reduced post-public issue capital base requirement from Rs10
crore to Rs3 crore to attract listing by companies with a smaller capital base It also
45
started a new trading segment small cap stock segment known as the Slsquo segment
Corporate with minimum turnover of an equal amount would be eligible to list scrips
on this segment In addition stocks listed on the regional exchanges would also be
able to list on the lsquoSlsquo segment subject to meeting certain criteria
2810 Base Market capitalization Adjustment
The formula for adjusting the Base Market capitalization is as follows
New Base Market Capitalization (NBMC)
New Market capitalization
NBMC = Old Base Market capitalization x mdashmdashmdashmdashmdashmdashmdashmdashmdashmdashmdash
Old Market capitalization
To illustrate suppose a company issues right shares which increases the market
capitalization of the shares of that company by say Rs100 crores The existing Base
Market capitalization (Old Base Market capitalization) say is Rs2450 crores and the
aggregate market capitalization of all the shares included in the index before the right
issue is made is say Rs4781 crore The New Base Market capitalization will then
be
2450x (4781+100)
_____________________ = Rs250124 crores
4781
This figure of Rs 250124 crore will be used as the Base Market capitalization for
calculating the index number from then onwards till the next base change becomes
necessary
Index Review Frequency
The BSE 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
29 STOCK MARKET INDEX
The stock market index is the most important indices of all as it measures overall
market sentiment through a set of stocks that representative of the market The stock
46
market index is a barometer of the market behavior It reflects direction and indicates
day-to-day fluctuations in stock prices The market index reflects expectations about
the behavior of the economy as a whole It is a precursor of economic cycles The
function of a stock index is to provide investors with information regarding the
average share price in the market An ideal index must represent changes in the prices
of the scrips and reflect price movements of typical shares for better market
representation Stock index is a barometer of a nationlsquos economic health as market
prices reflect expectations about the economylsquos performance Stock indices termed as
leading economic as they indicate what is going to happen in the economy in the
future The returns generated in the stock market are based on future expectations A
good market index incorporates a set of scrips which have high market capitalization
and high liquidity Market capitalization is the sum of the market value of all the
stocks included in the index The market value is derived by multiplying the price of
the share outstanding In other words the bid-ask spread is minimum The index on a
day is calculated as the percentage of the aggregate market value of the set of scrips
incorporated in the index on that day to the average market value of the same scrips
during the base period
291 Definition of an Index
A price index is such as the stock market price of the individual securities in the
market It reflects the overall price or return movements of a group of securities
Movements in an index are determined by sample weighting and computational
procedure Sample is normally generated by random selection or try a non random
selection technique designed to incorporate desired characteristics are used to select
sample shares rather than by completely random selection Major criteria for selection
are market activity due representation to various industrial groups and to major stock
exchanges
292 Global Stock Market Indices
2921 The Dow Jones Industrial averagersquos
It is the most widely watched and quoted index because of its long existence The
Dow has 30 constituents and it follows the methodology of price based weighted
47
Changes to stocks included in the Dow are infrequent three stocks were
addeddropped in 1991 four in 1997 and four in 1999 The addition of Microsoft and
Intel in 1999 was the first inclusion of Nasdaq market stocks to the Dow 30
2922 The Nasdaq composite index
The index is the market capitalization weighted of prices for all the stocks listed in the
Nasdaq stock market The Nasdaq composite began on 8 February 1971 with a base
of 100
2923 The Nasdaq 100 index
Nasdaq 100 comprises the largest computer software and telecom stocks by market
capitalization on the Nasdaq For a company to be included in the Nasdaq 100 it must
have a minimum average trading volume of 100000 shares per day and must have
been trading on a major exchange for at least a year or two
2924 The S amp P 500 index
This index comprises 500 biggest publicly traded companies in the US by market
capitalization Most money managers treat the S amp P 500 as a proxy for the US stock
market The S amp P 500 tries to cover all major areas of US economy To be included a
company must be profitable the prospective company must not be closely hold and
must have a large trading volume for its shares
2925 The FTSE 100
The FTSE 100 consists of the largest 100 companies by full market Value listed on
the London Stock Exchange The FTSE 100 is the benchmark index to indicate the
performance of the European market It is a market capitalization weighted index that
also considers the free float weighted of individual stocks before including them in
the index
2926 The MSCI Indices
Include the MSCIEAFE (Europe Australia and Far East) MSCI Europe MSCI
world MSCI (EMF) and MSCI Pacific Basin Indices
48
The MSCI world Index is a free float adjusted market capitalization index that is
designed to measure global developed market equity performance As of April 2002
the MSCI world Index consisted of the MSCI world Index consisted of the following
23 developed market country indices
Australia Austria Belgium Canada Denmark Finland France Germany Greece
Hong Kong Ireland Italy Japan Netherlands New Zealand Norway Singapore
Portugal Spain Sweden Switzerland United Kingdom and the United States of
America
293 Methodology for Calculating The Index
2931 Price Weighted Index
In this method the price of each stock in the index is summed up which is then
equated to an index starting value An arbitrary date is set as the base and the
Laspeyerlsquos Price Index which measures price changes against a fixed base period
quantity weight is used In case of a stock split the market price of the stock falls and
these results in less weighted in the index The Dow Jones Industrial Average and
Nikkie 225 are price-weighted indices
2932 Equal Weighting
In this method each stocklsquos percentage weight in the index is equal and hence all
stocks have an equal influence on the index movement The value line index at
Kansas City Board of Trade (KCBT) is an equal weighted index
2933 Market Capitalization Weighted
29331 Full Market Capitalization Method
In this method the number of shares outstanding multiplied by the market price of a
companylsquos share determines the scriplsquos weighted in the index The shares with the
highest market capitalization would have a higher weighted and would be most
influential in this type of index Eg S amp P 500 Index in USA and S amp P CNX Nify in
India
49
29332 Modified Capitalization Weighted
This method seeks to limit the influence of the largest stocks in the index which
otherwise would dominate the entire index This method sets a limit on the largest
stock or a group of stocks The NASDAQ 100 Index is calculated by using this
method
294 Free Float Market Capitalization Method
2941 Concept
Free float methodology refers to an index construction methodology that takes in to
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 Strategic holding government 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
All BSE indices with exception of BSE-PSU index have adopted the free-float
methodology
2942 Definition of Free Float
Share holding of investor that would not in the normal course come into the
open market for trading are treated as ―Controlling Strategic Holding and
hence not included in free float specifically the following categories of
holding are generally excluded from the definition of free float
Shares hold by foundersdirectorsacquires which has control element
Shares held by person with ―Controlling Interestlsquo
Shares held by Govt as promoters
50
Holding through the FDI Route
Strategic Stakes by private corporate bodiesindividuals
Equity held by employee welfare trusts
Locked-in-shares and shares which not be sold in the open market in normal
course
2943 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-agrave-Vis an investible
index This enables an apple-to-apple comparison thereby facilitating better
evaluation of performance of active managers
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 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
The free float methodology of index construction is considered to be an industry best
practice and all major index providers like MSCI FTSE SampP 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
51
29441 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 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 055 means that only 55 of the market
capitalization of the company will be considered for index calculation
Table 24 Free-float Bands
Free-Float Free-Float Factor Free-Float Free-Float Factor
gt0 - 5 005 gt50 - 55 055
gt5 - 10 010 gt55 - 60 060
gt10 - 15 015 gt60 - 65 065
gt15 - 20 020 gt65 - 70 070
gt20 - 25 025 gt70 - 75 075
gt25 - 30 030 gt75 - 80 080
gt30 - 35 035 gt80 - 85 085
gt35 - 40 040 gt85 - 90 090
gt40 - 45 045 gt90 - 95 095
gt45 - 50 050 gt95 - 100 100
Source wwwbseindiacom
295 BSE Indices
For the premier stock exchange that pioneered the securities transaction business
in India over a century of experience is a proud achievement A lot has changed since
1875 when 318 persons by paying a then princely amount of Re 1 became members
of what today is called Bombay Stock Exchange Limited (BSE) Over the decades
the stock market in the country has passed through good and bad periods The journey
52
in the 20th century has not been an easy one Till the decade of eighties there was no
measure or scale that could precisely measure the various ups and downs in the Indian
stock market BSE in 1986 came out with a Stock Index-SENSEX- that subsequently
became the barometer of the Indian stock market
The launch of SENSEX in 1986 was later followed up in January 1989 by
introduction of BSE National Index (Base 1983-84 = 100) It comprised 100 stocks
listed at five major stock exchanges in India - Mumbai Calcutta Delhi Ahmadabad
and Madras The BSE National Index was renamed BSE-100 Index from October 14
1996 and since then it is being calculated taking into consideration only the prices of
stocks listed at BSE BSE launched the dollar-linked version of BSE-100 index on
May 22 2006
With a view to provide a better representation of the increasing number of listed
companies larger market capitalization and the new industry sectors BSE launched
on 27th May 1994 two new index series viz the BSE-200 and the DOLLEX-200
Since then BSE has come a long way in attuning itself to the varied needs of
investors and market participants In order to fulfill the need for still broader
segment-specific and sector-specific indices BSE has continuously been increasing
the range of its indices BSE-500 Index and 5 sectorial indices were launched in 1999
In 2001 BSE launched BSE-PSU Index DOLLEX-30 and the countrys first free-
float based index - the BSE TEC Index Over the years BSE shifted all its indices to
the free-float methodology
BSE disseminates information on the Price-Earnings Ratio the Price to Book Value
Ratio and the Dividend Yield Percentage on day-to-day basis of all its major indices
The values of all BSE indices are updated on real time basis during market hours and
displayed through the BOLT system BSE website and news wire agencies
All BSE Indices are reviewed periodically by the BSE Index Committee This
Committee which comprises eminent independent finance professionals frames the
broad policy guidelines for the development and maintenance of all BSE indices The
BSE Index Cell carries out the day-to-day maintenance of all indices and conducts
research on development of new indices
53
2951 BSE-100 Index
A broad-based index the BSE-100 was formerly known as the BSE National index
This Index has 1983-84 as the base year and was launched in 1989 In line with the
shift of the BSE Indices to the globally accepted Free-Float methodology BSE-100
was shifted to Free-Float methodology effective from April 5 2004 The method of
computation of Free-Float index and determination of free-float factors is similar to
the methodology for SENSEX
Table 25 Index Specification
Base Year 1983-84
Base Index Value 100
Date of Launch 3-Jan-89
Method of calculation Launched on full market capitalization
method and effective April 05 2004
calculation method shifted to free-float
market capitalization
Number of scrips 100
Index calculation frequency Real Time
Source wwwbseindiacom
2952 Base Year
The financial year 1983-84 has been chosen as the base year The price stability
during that year and proximity to the index series were the main consideration for
choice of 1983-84 as the base year The base value was fixed at 100 points
2953 Dollex-100
BSE also calculates a dollar-linked version of SENSEX and historical values of this
index are available since its inception
2954 BSE-100 index - Scrip Selection Criteria
The general guidelines for selection of constituents in BSE-100 are as follows
Trading Frequency The scrip should have been traded on 95 of the trading days
54
in the last three months Exceptions can be made for extreme reasons like scrip
suspension etc
Final Rank The scrip should figure in the top 200 companies listed by final rank
The final rank is arrived at by assigning 75 weighted to the rank on the basis of
three-month average full market capitalization and 25 weighted to the liquidity rank
based on three-month average daily turnover amp three-month average impact cost
IndustrySector Representation Scrip selection would generally take into account a
balanced sectorial representation of the listed companies in the universe of BSE
Track Record In the opinion of the BSE Index Committee the company should
have an acceptable track record
210 STOCK MARKET VOLATILITY
2101 Meaning
Volatility is a measure for variation of price of a financial instrument over time
Historic volatility is derived from time series of past market prices An implied
volatility is derived from the market price of a market traded derivative (in particular
an option) Volatility does not measure the direction of price changes merely their
dispersion This is because when calculating standard deviation (or variance) all
differences are squared so that negative and positive differences are combined into
one quantity Two instruments with different volatilities may have the same expected
return but the instrument with higher volatility will have larger swings in values over
a given period of time
For example a lower volatility stock may have an expected (average) return of 7
with annual volatility of 5 This would indicate returns from approximately negative
3 to positive 17 most of the time (19 times out of 20 or 95 via a two standard
deviation rule) A higher volatility stock with the same expected return of 7 but
with annual volatility of 20 would indicate returns from approximately negative
33 to positive 47 most of the time (19 times out of 20 or 95) These estimates
assume a normal distribution in reality stocks are found to be leptokurtotic
55
2102 Terminology used in volatility
Volatility as described here refers to the actual current volatility of a financial
instrument for a specified period (for example 30 days or 90 days) It is the volatility
of a financial instrument based on historical prices over the specified period with the
last observation the most recent price This phrase is used particularly when it is
wished to distinguish between the actual current volatility of an instrument and
actual historical volatility which refers to the volatility of a financial instrument
over a specified period but with the last observation on a date in the past
actual future volatility which refers to the volatility of a financial instrument
over a specified period starting at the current time and ending at a future date
(normally the expiry date of an options)
historical implied volatility which refers to the implied volatility observed from
historical prices of the financial instrument (normally options)
current implied volatility which refers to the implied volatility observed from
current prices of the financial instrument
future implied volatility which refers to the implied volatility observed from
future prices of the financial instrument
For a financial instrument whose price follows a random walk or wiener process the
width of the distribution increases as time increases This is because there is an
increasing profitability that the instruments price will be farther away from the initial
price as time increases However rather than increase linearly the volatility increases
with the square-root of time as time increases because some fluctuations are expected
to cancel each other out so the most likely deviation after twice the time will not be
twice the distance from zero
2103 Usefulness of volatility for Investors
Investors care about volatility for five reasons
1 The wider the swings in an investments price the harder emotionally it is to
not worry
2 Price volatility of a trading instrument can define position sizing in a portfolio
56
3 When certain cash flows from selling a security are needed at a specific future
date higher volatility means a greater chance of a shortfall
4 Higher volatility of returns while saving for retirement results in a wider
distribution of possible final portfolio values
5 Higher volatility of return when retired gives withdrawals a larger permanent
impact on the portfolios value
6 Price volatility presents opportunities to buy assets cheaply and sell when
overpriced
39
281 History of the Bombay Stock exchange
Trading in securities has been in vogue in India for a little over 200 years Trading in
securities dates back 1793 most of them being transactions in loan securities of the
East India Company The broking community prospered as there was a rise in prices
which led to a share mania during 1861-65 This bubble burst in 1865 when the
American Civil War ended The brokers realized that investor confidence in the
securities market could be sustained only by organizing themselves into a regulated
body with defined rules and regulations The realization resulted in formation of ―The
Native Share and Stock Brokerslsquo Association which later came to be known as the
Bombay Stock Exchange In 1875 these brokers assembled at a place now called
Dalal Street
The Bombay Stock Exchange is a voluntary nonprofit making association of broker
members It emerged as a premier stock exchange after the 1960 The increased pace
of industrialization caused by the two world wars protection to the domestic industry
and the governmentlsquos fiscal policies aided the growth of new issues which in turn
helped the BSE to prosper The BSE dominated the Indian Capital Market by
accounting for more than 60 per cent of the all Indian turn over
Until 1992 the BSE operated like a closed club of selected members With the
securities scam outburst in 1992 and the SEBI taking over the rains of the Stock
Market the BSE had to bring about changes in its operational policies Until March
1995 the BSE had an open outcry system of trading However when faced with stiff
competition from NSE the countrylsquos first modern computerized and professionally
managed stock exchange set up in 1994 the BSE had to change its system of trading
and operation
On 14 March 1995 the BSE turned to electronic trading whereby brokers trade using
computers This system is known as the BSE On-line Trading System (BOLT)
The introduction of BOLT helped in improving trading volumes significantly
reducing the spread between buy and sell orders better trading in odd lot shares fixed
income instruments and dealings in the renunciation of rights shares
40
In 1995 BOLT was limited to Mumbai whereas the NSE was operating at the
national level As a result the BSE submitted a proposal for allowing installation of
terminals connected to BOLT in centers outside Mumbai After rejecting the proposal
four times on 29 october 1996 the SEBI finally allowed the BSE to use its BOLT
system nationwide Later the BSE set up a central depository system to dematerialize
shares and promote demate Account (trading)
282 Hours of Operation
Beginning of the Day Session 800 to 900
Trading Session 900 to 1530
Position Transfer Session 1530 to 1550
Closing Session 1550 to 1605
Option Exercise Session 1605 to 1635
Margin Session 1635 to 1650
Query Session 1650 to1735
End of Day Session 1735
The hours of operation for the BSE quoted above are stated in terms of the local time
(ie GMT+530) in Mumbai India
BSElsquos normal trading sessions are on all days of the week except Saturdays Sundays
and Holidays declared by the Exchange in advance 36
283 Services of BSE
BSE also had a wide range of services to empower investors and facilitate smooth
transactions These services are as follows
2831 Investor Services
The Dept of investor services redresses grievances of investors BSE was the first
exchange in the country to provide an amount of Rs 1 million towards the investor
36 Asia Technical Analysis with Phil Smith wwwreutersindianet
41
protection fund it is an amount higher than that of any exchange in the country BSE
launched a nationwide investor awareness program ―Safe Investing in the Stock
Market under which 264 programmers were held in more than 200 cities
2832 The BSE Online Trading (BOLT)
BSE on line Trading (BOLT) facilities on-line screen based trading in securities
BOLT is currently operating in 25000 trader work stations located across over 399
cities in India
2833 BSEWEBXcom
In February 2001 BSE introduced the worldlsquos first centralized exchange based
Internet trading system BSEWEBXcom This initiative enables investors anywhere
in the world to trade on BSE platform
2834 Surveillance
BSElsquos Online Surveillance System (BOSS) monitors on a real time basis the price
movements volume position and real time measurements of the default risk market
reconstruct and generation of cross market alerts
2835 BSE Training Institute
BTI imparts capital market training and certification in collaboration with reputed
management institutes and universities It offers over 40 courses on various aspects of
the capital mark and financial sector More than 20000 people have attended the BTI
program
284 Awards
Fowling awards were given to BSE
The world council of Corporate Governance has awarded the Golden Peacock
Global CSR Award for BSElsquos initiatives in corporate social responsibility
The Annual Reports and Accounts of BSE for the year ended March 312006 and
42
March 312007 have been awarded the ICAI awards for excellence in financial
reporting
The Human Resource Management at BSE has won the Asia-Pacific HRM awards
for its efforts in employer branding through talent management at work health
management at work and excellence in HR through technology
Drawing from its rich past and its equally robust performance in the recent times
BSE will continue to remain an icon in the Indian Capital Market
285 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 days closing price is taken for computation of Index closure
The use of Index Closure Algorithm prevents any intentional manipulation of the
closing index value
286 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 affect the
index values The BSE Index Cell does the day-to-day maintenance of the index
within the broad index policy framework set by the BSE Index Committee The BSE
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 BSE Index Committee comprises
of capital market expert fund managers market participants and members of the BSE
Governing Board
43
287 On-Line Computation of the Index
During trading hours value of the Index is calculated and disseminated on real time
basis This is done automatically on the basis of prices at which trades in Index
constituents are executed
288 Adjustment for Bonus Rights and Newly Issued Capital
SENSEX calculation needs to be adjusted for issue of Bonus or 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 BSE Index Cell the base value is adjusted which is used to alter
market capitalization of the component stocks to arrive at the SENSEX value The
BSE Index Cell keeps a close watch on the events that might affect the index on a
regular basis and carries out daily maintenance of all the 19 Indices
2881 Adjustments for Rights Issues
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 (ex-right) price An offsetting or
proportionate adjustment is then made to the Base Market capitalization
2882 Adjustments for Bonus Issue
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
2883 Other Issues 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
buy-back of shares corporate restructuring etc
44
289 Listing Categories
Before badla was resumed in 1996 there were only two categories of securities listed
on the BSE the specified group of shares comprising The securities in which carry
forward deals were allowed and the cash group shares in which no carry forward deals
were permitted Later it was observed that the facility of carry forward was not being
used in all the 94 scrips in the specified group Hence after badla was resumed the
size of the specified group was reduced to 32 scrips on 3 April 1996 The BSE later
decided to regroup the existing A and B group shares into three categories The BSE
delisted 637 companies for a period of 3 years during 2004-05 for non-compliance of
listing agreements
A Group This group consists of large stock with turnover and high floating stock
with large market capitalization In other words scrips with more liquidity and high
networth are included in this group At present there are 150 scrips in this group
B1 Group This group includes scrips of quality companies with equity above Rs 3
crore with high growth potential and trading frequency No carry forward facility was
allowed in this group in June 2000 there were 1803 scrips in this group
B2 Group Scrips in this group were just like those of B1 but with fortnightly
settlement However in September 1996 the BSE introduced weekly settlement for all
scrips listed on the exchange thus doing away with the distinction between the B1 and
B2 groups On June 2000 there were 3219 scrips in this group
Z Group Subsequently a Z group was introduced in 1999 with scrips of companies
that do not meet the rules regulations and stipulations laid down by the exchange It
is a buyer beware company These are some 300 scrips in the group All Z category
stocks result in delivers
F Group A new Flsquo group pertaining to debt market segment was started with effect
from 9 September 1996
S Group The BSE reduced post-public issue capital base requirement from Rs10
crore to Rs3 crore to attract listing by companies with a smaller capital base It also
45
started a new trading segment small cap stock segment known as the Slsquo segment
Corporate with minimum turnover of an equal amount would be eligible to list scrips
on this segment In addition stocks listed on the regional exchanges would also be
able to list on the lsquoSlsquo segment subject to meeting certain criteria
2810 Base Market capitalization Adjustment
The formula for adjusting the Base Market capitalization is as follows
New Base Market Capitalization (NBMC)
New Market capitalization
NBMC = Old Base Market capitalization x mdashmdashmdashmdashmdashmdashmdashmdashmdashmdashmdash
Old Market capitalization
To illustrate suppose a company issues right shares which increases the market
capitalization of the shares of that company by say Rs100 crores The existing Base
Market capitalization (Old Base Market capitalization) say is Rs2450 crores and the
aggregate market capitalization of all the shares included in the index before the right
issue is made is say Rs4781 crore The New Base Market capitalization will then
be
2450x (4781+100)
_____________________ = Rs250124 crores
4781
This figure of Rs 250124 crore will be used as the Base Market capitalization for
calculating the index number from then onwards till the next base change becomes
necessary
Index Review Frequency
The BSE 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
29 STOCK MARKET INDEX
The stock market index is the most important indices of all as it measures overall
market sentiment through a set of stocks that representative of the market The stock
46
market index is a barometer of the market behavior It reflects direction and indicates
day-to-day fluctuations in stock prices The market index reflects expectations about
the behavior of the economy as a whole It is a precursor of economic cycles The
function of a stock index is to provide investors with information regarding the
average share price in the market An ideal index must represent changes in the prices
of the scrips and reflect price movements of typical shares for better market
representation Stock index is a barometer of a nationlsquos economic health as market
prices reflect expectations about the economylsquos performance Stock indices termed as
leading economic as they indicate what is going to happen in the economy in the
future The returns generated in the stock market are based on future expectations A
good market index incorporates a set of scrips which have high market capitalization
and high liquidity Market capitalization is the sum of the market value of all the
stocks included in the index The market value is derived by multiplying the price of
the share outstanding In other words the bid-ask spread is minimum The index on a
day is calculated as the percentage of the aggregate market value of the set of scrips
incorporated in the index on that day to the average market value of the same scrips
during the base period
291 Definition of an Index
A price index is such as the stock market price of the individual securities in the
market It reflects the overall price or return movements of a group of securities
Movements in an index are determined by sample weighting and computational
procedure Sample is normally generated by random selection or try a non random
selection technique designed to incorporate desired characteristics are used to select
sample shares rather than by completely random selection Major criteria for selection
are market activity due representation to various industrial groups and to major stock
exchanges
292 Global Stock Market Indices
2921 The Dow Jones Industrial averagersquos
It is the most widely watched and quoted index because of its long existence The
Dow has 30 constituents and it follows the methodology of price based weighted
47
Changes to stocks included in the Dow are infrequent three stocks were
addeddropped in 1991 four in 1997 and four in 1999 The addition of Microsoft and
Intel in 1999 was the first inclusion of Nasdaq market stocks to the Dow 30
2922 The Nasdaq composite index
The index is the market capitalization weighted of prices for all the stocks listed in the
Nasdaq stock market The Nasdaq composite began on 8 February 1971 with a base
of 100
2923 The Nasdaq 100 index
Nasdaq 100 comprises the largest computer software and telecom stocks by market
capitalization on the Nasdaq For a company to be included in the Nasdaq 100 it must
have a minimum average trading volume of 100000 shares per day and must have
been trading on a major exchange for at least a year or two
2924 The S amp P 500 index
This index comprises 500 biggest publicly traded companies in the US by market
capitalization Most money managers treat the S amp P 500 as a proxy for the US stock
market The S amp P 500 tries to cover all major areas of US economy To be included a
company must be profitable the prospective company must not be closely hold and
must have a large trading volume for its shares
2925 The FTSE 100
The FTSE 100 consists of the largest 100 companies by full market Value listed on
the London Stock Exchange The FTSE 100 is the benchmark index to indicate the
performance of the European market It is a market capitalization weighted index that
also considers the free float weighted of individual stocks before including them in
the index
2926 The MSCI Indices
Include the MSCIEAFE (Europe Australia and Far East) MSCI Europe MSCI
world MSCI (EMF) and MSCI Pacific Basin Indices
48
The MSCI world Index is a free float adjusted market capitalization index that is
designed to measure global developed market equity performance As of April 2002
the MSCI world Index consisted of the MSCI world Index consisted of the following
23 developed market country indices
Australia Austria Belgium Canada Denmark Finland France Germany Greece
Hong Kong Ireland Italy Japan Netherlands New Zealand Norway Singapore
Portugal Spain Sweden Switzerland United Kingdom and the United States of
America
293 Methodology for Calculating The Index
2931 Price Weighted Index
In this method the price of each stock in the index is summed up which is then
equated to an index starting value An arbitrary date is set as the base and the
Laspeyerlsquos Price Index which measures price changes against a fixed base period
quantity weight is used In case of a stock split the market price of the stock falls and
these results in less weighted in the index The Dow Jones Industrial Average and
Nikkie 225 are price-weighted indices
2932 Equal Weighting
In this method each stocklsquos percentage weight in the index is equal and hence all
stocks have an equal influence on the index movement The value line index at
Kansas City Board of Trade (KCBT) is an equal weighted index
2933 Market Capitalization Weighted
29331 Full Market Capitalization Method
In this method the number of shares outstanding multiplied by the market price of a
companylsquos share determines the scriplsquos weighted in the index The shares with the
highest market capitalization would have a higher weighted and would be most
influential in this type of index Eg S amp P 500 Index in USA and S amp P CNX Nify in
India
49
29332 Modified Capitalization Weighted
This method seeks to limit the influence of the largest stocks in the index which
otherwise would dominate the entire index This method sets a limit on the largest
stock or a group of stocks The NASDAQ 100 Index is calculated by using this
method
294 Free Float Market Capitalization Method
2941 Concept
Free float methodology refers to an index construction methodology that takes in to
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 Strategic holding government 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
All BSE indices with exception of BSE-PSU index have adopted the free-float
methodology
2942 Definition of Free Float
Share holding of investor that would not in the normal course come into the
open market for trading are treated as ―Controlling Strategic Holding and
hence not included in free float specifically the following categories of
holding are generally excluded from the definition of free float
Shares hold by foundersdirectorsacquires which has control element
Shares held by person with ―Controlling Interestlsquo
Shares held by Govt as promoters
50
Holding through the FDI Route
Strategic Stakes by private corporate bodiesindividuals
Equity held by employee welfare trusts
Locked-in-shares and shares which not be sold in the open market in normal
course
2943 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-agrave-Vis an investible
index This enables an apple-to-apple comparison thereby facilitating better
evaluation of performance of active managers
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 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
The free float methodology of index construction is considered to be an industry best
practice and all major index providers like MSCI FTSE SampP 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
51
29441 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 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 055 means that only 55 of the market
capitalization of the company will be considered for index calculation
Table 24 Free-float Bands
Free-Float Free-Float Factor Free-Float Free-Float Factor
gt0 - 5 005 gt50 - 55 055
gt5 - 10 010 gt55 - 60 060
gt10 - 15 015 gt60 - 65 065
gt15 - 20 020 gt65 - 70 070
gt20 - 25 025 gt70 - 75 075
gt25 - 30 030 gt75 - 80 080
gt30 - 35 035 gt80 - 85 085
gt35 - 40 040 gt85 - 90 090
gt40 - 45 045 gt90 - 95 095
gt45 - 50 050 gt95 - 100 100
Source wwwbseindiacom
295 BSE Indices
For the premier stock exchange that pioneered the securities transaction business
in India over a century of experience is a proud achievement A lot has changed since
1875 when 318 persons by paying a then princely amount of Re 1 became members
of what today is called Bombay Stock Exchange Limited (BSE) Over the decades
the stock market in the country has passed through good and bad periods The journey
52
in the 20th century has not been an easy one Till the decade of eighties there was no
measure or scale that could precisely measure the various ups and downs in the Indian
stock market BSE in 1986 came out with a Stock Index-SENSEX- that subsequently
became the barometer of the Indian stock market
The launch of SENSEX in 1986 was later followed up in January 1989 by
introduction of BSE National Index (Base 1983-84 = 100) It comprised 100 stocks
listed at five major stock exchanges in India - Mumbai Calcutta Delhi Ahmadabad
and Madras The BSE National Index was renamed BSE-100 Index from October 14
1996 and since then it is being calculated taking into consideration only the prices of
stocks listed at BSE BSE launched the dollar-linked version of BSE-100 index on
May 22 2006
With a view to provide a better representation of the increasing number of listed
companies larger market capitalization and the new industry sectors BSE launched
on 27th May 1994 two new index series viz the BSE-200 and the DOLLEX-200
Since then BSE has come a long way in attuning itself to the varied needs of
investors and market participants In order to fulfill the need for still broader
segment-specific and sector-specific indices BSE has continuously been increasing
the range of its indices BSE-500 Index and 5 sectorial indices were launched in 1999
In 2001 BSE launched BSE-PSU Index DOLLEX-30 and the countrys first free-
float based index - the BSE TEC Index Over the years BSE shifted all its indices to
the free-float methodology
BSE disseminates information on the Price-Earnings Ratio the Price to Book Value
Ratio and the Dividend Yield Percentage on day-to-day basis of all its major indices
The values of all BSE indices are updated on real time basis during market hours and
displayed through the BOLT system BSE website and news wire agencies
All BSE Indices are reviewed periodically by the BSE Index Committee This
Committee which comprises eminent independent finance professionals frames the
broad policy guidelines for the development and maintenance of all BSE indices The
BSE Index Cell carries out the day-to-day maintenance of all indices and conducts
research on development of new indices
53
2951 BSE-100 Index
A broad-based index the BSE-100 was formerly known as the BSE National index
This Index has 1983-84 as the base year and was launched in 1989 In line with the
shift of the BSE Indices to the globally accepted Free-Float methodology BSE-100
was shifted to Free-Float methodology effective from April 5 2004 The method of
computation of Free-Float index and determination of free-float factors is similar to
the methodology for SENSEX
Table 25 Index Specification
Base Year 1983-84
Base Index Value 100
Date of Launch 3-Jan-89
Method of calculation Launched on full market capitalization
method and effective April 05 2004
calculation method shifted to free-float
market capitalization
Number of scrips 100
Index calculation frequency Real Time
Source wwwbseindiacom
2952 Base Year
The financial year 1983-84 has been chosen as the base year The price stability
during that year and proximity to the index series were the main consideration for
choice of 1983-84 as the base year The base value was fixed at 100 points
2953 Dollex-100
BSE also calculates a dollar-linked version of SENSEX and historical values of this
index are available since its inception
2954 BSE-100 index - Scrip Selection Criteria
The general guidelines for selection of constituents in BSE-100 are as follows
Trading Frequency The scrip should have been traded on 95 of the trading days
54
in the last three months Exceptions can be made for extreme reasons like scrip
suspension etc
Final Rank The scrip should figure in the top 200 companies listed by final rank
The final rank is arrived at by assigning 75 weighted to the rank on the basis of
three-month average full market capitalization and 25 weighted to the liquidity rank
based on three-month average daily turnover amp three-month average impact cost
IndustrySector Representation Scrip selection would generally take into account a
balanced sectorial representation of the listed companies in the universe of BSE
Track Record In the opinion of the BSE Index Committee the company should
have an acceptable track record
210 STOCK MARKET VOLATILITY
2101 Meaning
Volatility is a measure for variation of price of a financial instrument over time
Historic volatility is derived from time series of past market prices An implied
volatility is derived from the market price of a market traded derivative (in particular
an option) Volatility does not measure the direction of price changes merely their
dispersion This is because when calculating standard deviation (or variance) all
differences are squared so that negative and positive differences are combined into
one quantity Two instruments with different volatilities may have the same expected
return but the instrument with higher volatility will have larger swings in values over
a given period of time
For example a lower volatility stock may have an expected (average) return of 7
with annual volatility of 5 This would indicate returns from approximately negative
3 to positive 17 most of the time (19 times out of 20 or 95 via a two standard
deviation rule) A higher volatility stock with the same expected return of 7 but
with annual volatility of 20 would indicate returns from approximately negative
33 to positive 47 most of the time (19 times out of 20 or 95) These estimates
assume a normal distribution in reality stocks are found to be leptokurtotic
55
2102 Terminology used in volatility
Volatility as described here refers to the actual current volatility of a financial
instrument for a specified period (for example 30 days or 90 days) It is the volatility
of a financial instrument based on historical prices over the specified period with the
last observation the most recent price This phrase is used particularly when it is
wished to distinguish between the actual current volatility of an instrument and
actual historical volatility which refers to the volatility of a financial instrument
over a specified period but with the last observation on a date in the past
actual future volatility which refers to the volatility of a financial instrument
over a specified period starting at the current time and ending at a future date
(normally the expiry date of an options)
historical implied volatility which refers to the implied volatility observed from
historical prices of the financial instrument (normally options)
current implied volatility which refers to the implied volatility observed from
current prices of the financial instrument
future implied volatility which refers to the implied volatility observed from
future prices of the financial instrument
For a financial instrument whose price follows a random walk or wiener process the
width of the distribution increases as time increases This is because there is an
increasing profitability that the instruments price will be farther away from the initial
price as time increases However rather than increase linearly the volatility increases
with the square-root of time as time increases because some fluctuations are expected
to cancel each other out so the most likely deviation after twice the time will not be
twice the distance from zero
2103 Usefulness of volatility for Investors
Investors care about volatility for five reasons
1 The wider the swings in an investments price the harder emotionally it is to
not worry
2 Price volatility of a trading instrument can define position sizing in a portfolio
56
3 When certain cash flows from selling a security are needed at a specific future
date higher volatility means a greater chance of a shortfall
4 Higher volatility of returns while saving for retirement results in a wider
distribution of possible final portfolio values
5 Higher volatility of return when retired gives withdrawals a larger permanent
impact on the portfolios value
6 Price volatility presents opportunities to buy assets cheaply and sell when
overpriced
40
In 1995 BOLT was limited to Mumbai whereas the NSE was operating at the
national level As a result the BSE submitted a proposal for allowing installation of
terminals connected to BOLT in centers outside Mumbai After rejecting the proposal
four times on 29 october 1996 the SEBI finally allowed the BSE to use its BOLT
system nationwide Later the BSE set up a central depository system to dematerialize
shares and promote demate Account (trading)
282 Hours of Operation
Beginning of the Day Session 800 to 900
Trading Session 900 to 1530
Position Transfer Session 1530 to 1550
Closing Session 1550 to 1605
Option Exercise Session 1605 to 1635
Margin Session 1635 to 1650
Query Session 1650 to1735
End of Day Session 1735
The hours of operation for the BSE quoted above are stated in terms of the local time
(ie GMT+530) in Mumbai India
BSElsquos normal trading sessions are on all days of the week except Saturdays Sundays
and Holidays declared by the Exchange in advance 36
283 Services of BSE
BSE also had a wide range of services to empower investors and facilitate smooth
transactions These services are as follows
2831 Investor Services
The Dept of investor services redresses grievances of investors BSE was the first
exchange in the country to provide an amount of Rs 1 million towards the investor
36 Asia Technical Analysis with Phil Smith wwwreutersindianet
41
protection fund it is an amount higher than that of any exchange in the country BSE
launched a nationwide investor awareness program ―Safe Investing in the Stock
Market under which 264 programmers were held in more than 200 cities
2832 The BSE Online Trading (BOLT)
BSE on line Trading (BOLT) facilities on-line screen based trading in securities
BOLT is currently operating in 25000 trader work stations located across over 399
cities in India
2833 BSEWEBXcom
In February 2001 BSE introduced the worldlsquos first centralized exchange based
Internet trading system BSEWEBXcom This initiative enables investors anywhere
in the world to trade on BSE platform
2834 Surveillance
BSElsquos Online Surveillance System (BOSS) monitors on a real time basis the price
movements volume position and real time measurements of the default risk market
reconstruct and generation of cross market alerts
2835 BSE Training Institute
BTI imparts capital market training and certification in collaboration with reputed
management institutes and universities It offers over 40 courses on various aspects of
the capital mark and financial sector More than 20000 people have attended the BTI
program
284 Awards
Fowling awards were given to BSE
The world council of Corporate Governance has awarded the Golden Peacock
Global CSR Award for BSElsquos initiatives in corporate social responsibility
The Annual Reports and Accounts of BSE for the year ended March 312006 and
42
March 312007 have been awarded the ICAI awards for excellence in financial
reporting
The Human Resource Management at BSE has won the Asia-Pacific HRM awards
for its efforts in employer branding through talent management at work health
management at work and excellence in HR through technology
Drawing from its rich past and its equally robust performance in the recent times
BSE will continue to remain an icon in the Indian Capital Market
285 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 days closing price is taken for computation of Index closure
The use of Index Closure Algorithm prevents any intentional manipulation of the
closing index value
286 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 affect the
index values The BSE Index Cell does the day-to-day maintenance of the index
within the broad index policy framework set by the BSE Index Committee The BSE
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 BSE Index Committee comprises
of capital market expert fund managers market participants and members of the BSE
Governing Board
43
287 On-Line Computation of the Index
During trading hours value of the Index is calculated and disseminated on real time
basis This is done automatically on the basis of prices at which trades in Index
constituents are executed
288 Adjustment for Bonus Rights and Newly Issued Capital
SENSEX calculation needs to be adjusted for issue of Bonus or 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 BSE Index Cell the base value is adjusted which is used to alter
market capitalization of the component stocks to arrive at the SENSEX value The
BSE Index Cell keeps a close watch on the events that might affect the index on a
regular basis and carries out daily maintenance of all the 19 Indices
2881 Adjustments for Rights Issues
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 (ex-right) price An offsetting or
proportionate adjustment is then made to the Base Market capitalization
2882 Adjustments for Bonus Issue
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
2883 Other Issues 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
buy-back of shares corporate restructuring etc
44
289 Listing Categories
Before badla was resumed in 1996 there were only two categories of securities listed
on the BSE the specified group of shares comprising The securities in which carry
forward deals were allowed and the cash group shares in which no carry forward deals
were permitted Later it was observed that the facility of carry forward was not being
used in all the 94 scrips in the specified group Hence after badla was resumed the
size of the specified group was reduced to 32 scrips on 3 April 1996 The BSE later
decided to regroup the existing A and B group shares into three categories The BSE
delisted 637 companies for a period of 3 years during 2004-05 for non-compliance of
listing agreements
A Group This group consists of large stock with turnover and high floating stock
with large market capitalization In other words scrips with more liquidity and high
networth are included in this group At present there are 150 scrips in this group
B1 Group This group includes scrips of quality companies with equity above Rs 3
crore with high growth potential and trading frequency No carry forward facility was
allowed in this group in June 2000 there were 1803 scrips in this group
B2 Group Scrips in this group were just like those of B1 but with fortnightly
settlement However in September 1996 the BSE introduced weekly settlement for all
scrips listed on the exchange thus doing away with the distinction between the B1 and
B2 groups On June 2000 there were 3219 scrips in this group
Z Group Subsequently a Z group was introduced in 1999 with scrips of companies
that do not meet the rules regulations and stipulations laid down by the exchange It
is a buyer beware company These are some 300 scrips in the group All Z category
stocks result in delivers
F Group A new Flsquo group pertaining to debt market segment was started with effect
from 9 September 1996
S Group The BSE reduced post-public issue capital base requirement from Rs10
crore to Rs3 crore to attract listing by companies with a smaller capital base It also
45
started a new trading segment small cap stock segment known as the Slsquo segment
Corporate with minimum turnover of an equal amount would be eligible to list scrips
on this segment In addition stocks listed on the regional exchanges would also be
able to list on the lsquoSlsquo segment subject to meeting certain criteria
2810 Base Market capitalization Adjustment
The formula for adjusting the Base Market capitalization is as follows
New Base Market Capitalization (NBMC)
New Market capitalization
NBMC = Old Base Market capitalization x mdashmdashmdashmdashmdashmdashmdashmdashmdashmdashmdash
Old Market capitalization
To illustrate suppose a company issues right shares which increases the market
capitalization of the shares of that company by say Rs100 crores The existing Base
Market capitalization (Old Base Market capitalization) say is Rs2450 crores and the
aggregate market capitalization of all the shares included in the index before the right
issue is made is say Rs4781 crore The New Base Market capitalization will then
be
2450x (4781+100)
_____________________ = Rs250124 crores
4781
This figure of Rs 250124 crore will be used as the Base Market capitalization for
calculating the index number from then onwards till the next base change becomes
necessary
Index Review Frequency
The BSE 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
29 STOCK MARKET INDEX
The stock market index is the most important indices of all as it measures overall
market sentiment through a set of stocks that representative of the market The stock
46
market index is a barometer of the market behavior It reflects direction and indicates
day-to-day fluctuations in stock prices The market index reflects expectations about
the behavior of the economy as a whole It is a precursor of economic cycles The
function of a stock index is to provide investors with information regarding the
average share price in the market An ideal index must represent changes in the prices
of the scrips and reflect price movements of typical shares for better market
representation Stock index is a barometer of a nationlsquos economic health as market
prices reflect expectations about the economylsquos performance Stock indices termed as
leading economic as they indicate what is going to happen in the economy in the
future The returns generated in the stock market are based on future expectations A
good market index incorporates a set of scrips which have high market capitalization
and high liquidity Market capitalization is the sum of the market value of all the
stocks included in the index The market value is derived by multiplying the price of
the share outstanding In other words the bid-ask spread is minimum The index on a
day is calculated as the percentage of the aggregate market value of the set of scrips
incorporated in the index on that day to the average market value of the same scrips
during the base period
291 Definition of an Index
A price index is such as the stock market price of the individual securities in the
market It reflects the overall price or return movements of a group of securities
Movements in an index are determined by sample weighting and computational
procedure Sample is normally generated by random selection or try a non random
selection technique designed to incorporate desired characteristics are used to select
sample shares rather than by completely random selection Major criteria for selection
are market activity due representation to various industrial groups and to major stock
exchanges
292 Global Stock Market Indices
2921 The Dow Jones Industrial averagersquos
It is the most widely watched and quoted index because of its long existence The
Dow has 30 constituents and it follows the methodology of price based weighted
47
Changes to stocks included in the Dow are infrequent three stocks were
addeddropped in 1991 four in 1997 and four in 1999 The addition of Microsoft and
Intel in 1999 was the first inclusion of Nasdaq market stocks to the Dow 30
2922 The Nasdaq composite index
The index is the market capitalization weighted of prices for all the stocks listed in the
Nasdaq stock market The Nasdaq composite began on 8 February 1971 with a base
of 100
2923 The Nasdaq 100 index
Nasdaq 100 comprises the largest computer software and telecom stocks by market
capitalization on the Nasdaq For a company to be included in the Nasdaq 100 it must
have a minimum average trading volume of 100000 shares per day and must have
been trading on a major exchange for at least a year or two
2924 The S amp P 500 index
This index comprises 500 biggest publicly traded companies in the US by market
capitalization Most money managers treat the S amp P 500 as a proxy for the US stock
market The S amp P 500 tries to cover all major areas of US economy To be included a
company must be profitable the prospective company must not be closely hold and
must have a large trading volume for its shares
2925 The FTSE 100
The FTSE 100 consists of the largest 100 companies by full market Value listed on
the London Stock Exchange The FTSE 100 is the benchmark index to indicate the
performance of the European market It is a market capitalization weighted index that
also considers the free float weighted of individual stocks before including them in
the index
2926 The MSCI Indices
Include the MSCIEAFE (Europe Australia and Far East) MSCI Europe MSCI
world MSCI (EMF) and MSCI Pacific Basin Indices
48
The MSCI world Index is a free float adjusted market capitalization index that is
designed to measure global developed market equity performance As of April 2002
the MSCI world Index consisted of the MSCI world Index consisted of the following
23 developed market country indices
Australia Austria Belgium Canada Denmark Finland France Germany Greece
Hong Kong Ireland Italy Japan Netherlands New Zealand Norway Singapore
Portugal Spain Sweden Switzerland United Kingdom and the United States of
America
293 Methodology for Calculating The Index
2931 Price Weighted Index
In this method the price of each stock in the index is summed up which is then
equated to an index starting value An arbitrary date is set as the base and the
Laspeyerlsquos Price Index which measures price changes against a fixed base period
quantity weight is used In case of a stock split the market price of the stock falls and
these results in less weighted in the index The Dow Jones Industrial Average and
Nikkie 225 are price-weighted indices
2932 Equal Weighting
In this method each stocklsquos percentage weight in the index is equal and hence all
stocks have an equal influence on the index movement The value line index at
Kansas City Board of Trade (KCBT) is an equal weighted index
2933 Market Capitalization Weighted
29331 Full Market Capitalization Method
In this method the number of shares outstanding multiplied by the market price of a
companylsquos share determines the scriplsquos weighted in the index The shares with the
highest market capitalization would have a higher weighted and would be most
influential in this type of index Eg S amp P 500 Index in USA and S amp P CNX Nify in
India
49
29332 Modified Capitalization Weighted
This method seeks to limit the influence of the largest stocks in the index which
otherwise would dominate the entire index This method sets a limit on the largest
stock or a group of stocks The NASDAQ 100 Index is calculated by using this
method
294 Free Float Market Capitalization Method
2941 Concept
Free float methodology refers to an index construction methodology that takes in to
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 Strategic holding government 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
All BSE indices with exception of BSE-PSU index have adopted the free-float
methodology
2942 Definition of Free Float
Share holding of investor that would not in the normal course come into the
open market for trading are treated as ―Controlling Strategic Holding and
hence not included in free float specifically the following categories of
holding are generally excluded from the definition of free float
Shares hold by foundersdirectorsacquires which has control element
Shares held by person with ―Controlling Interestlsquo
Shares held by Govt as promoters
50
Holding through the FDI Route
Strategic Stakes by private corporate bodiesindividuals
Equity held by employee welfare trusts
Locked-in-shares and shares which not be sold in the open market in normal
course
2943 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-agrave-Vis an investible
index This enables an apple-to-apple comparison thereby facilitating better
evaluation of performance of active managers
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 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
The free float methodology of index construction is considered to be an industry best
practice and all major index providers like MSCI FTSE SampP 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
51
29441 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 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 055 means that only 55 of the market
capitalization of the company will be considered for index calculation
Table 24 Free-float Bands
Free-Float Free-Float Factor Free-Float Free-Float Factor
gt0 - 5 005 gt50 - 55 055
gt5 - 10 010 gt55 - 60 060
gt10 - 15 015 gt60 - 65 065
gt15 - 20 020 gt65 - 70 070
gt20 - 25 025 gt70 - 75 075
gt25 - 30 030 gt75 - 80 080
gt30 - 35 035 gt80 - 85 085
gt35 - 40 040 gt85 - 90 090
gt40 - 45 045 gt90 - 95 095
gt45 - 50 050 gt95 - 100 100
Source wwwbseindiacom
295 BSE Indices
For the premier stock exchange that pioneered the securities transaction business
in India over a century of experience is a proud achievement A lot has changed since
1875 when 318 persons by paying a then princely amount of Re 1 became members
of what today is called Bombay Stock Exchange Limited (BSE) Over the decades
the stock market in the country has passed through good and bad periods The journey
52
in the 20th century has not been an easy one Till the decade of eighties there was no
measure or scale that could precisely measure the various ups and downs in the Indian
stock market BSE in 1986 came out with a Stock Index-SENSEX- that subsequently
became the barometer of the Indian stock market
The launch of SENSEX in 1986 was later followed up in January 1989 by
introduction of BSE National Index (Base 1983-84 = 100) It comprised 100 stocks
listed at five major stock exchanges in India - Mumbai Calcutta Delhi Ahmadabad
and Madras The BSE National Index was renamed BSE-100 Index from October 14
1996 and since then it is being calculated taking into consideration only the prices of
stocks listed at BSE BSE launched the dollar-linked version of BSE-100 index on
May 22 2006
With a view to provide a better representation of the increasing number of listed
companies larger market capitalization and the new industry sectors BSE launched
on 27th May 1994 two new index series viz the BSE-200 and the DOLLEX-200
Since then BSE has come a long way in attuning itself to the varied needs of
investors and market participants In order to fulfill the need for still broader
segment-specific and sector-specific indices BSE has continuously been increasing
the range of its indices BSE-500 Index and 5 sectorial indices were launched in 1999
In 2001 BSE launched BSE-PSU Index DOLLEX-30 and the countrys first free-
float based index - the BSE TEC Index Over the years BSE shifted all its indices to
the free-float methodology
BSE disseminates information on the Price-Earnings Ratio the Price to Book Value
Ratio and the Dividend Yield Percentage on day-to-day basis of all its major indices
The values of all BSE indices are updated on real time basis during market hours and
displayed through the BOLT system BSE website and news wire agencies
All BSE Indices are reviewed periodically by the BSE Index Committee This
Committee which comprises eminent independent finance professionals frames the
broad policy guidelines for the development and maintenance of all BSE indices The
BSE Index Cell carries out the day-to-day maintenance of all indices and conducts
research on development of new indices
53
2951 BSE-100 Index
A broad-based index the BSE-100 was formerly known as the BSE National index
This Index has 1983-84 as the base year and was launched in 1989 In line with the
shift of the BSE Indices to the globally accepted Free-Float methodology BSE-100
was shifted to Free-Float methodology effective from April 5 2004 The method of
computation of Free-Float index and determination of free-float factors is similar to
the methodology for SENSEX
Table 25 Index Specification
Base Year 1983-84
Base Index Value 100
Date of Launch 3-Jan-89
Method of calculation Launched on full market capitalization
method and effective April 05 2004
calculation method shifted to free-float
market capitalization
Number of scrips 100
Index calculation frequency Real Time
Source wwwbseindiacom
2952 Base Year
The financial year 1983-84 has been chosen as the base year The price stability
during that year and proximity to the index series were the main consideration for
choice of 1983-84 as the base year The base value was fixed at 100 points
2953 Dollex-100
BSE also calculates a dollar-linked version of SENSEX and historical values of this
index are available since its inception
2954 BSE-100 index - Scrip Selection Criteria
The general guidelines for selection of constituents in BSE-100 are as follows
Trading Frequency The scrip should have been traded on 95 of the trading days
54
in the last three months Exceptions can be made for extreme reasons like scrip
suspension etc
Final Rank The scrip should figure in the top 200 companies listed by final rank
The final rank is arrived at by assigning 75 weighted to the rank on the basis of
three-month average full market capitalization and 25 weighted to the liquidity rank
based on three-month average daily turnover amp three-month average impact cost
IndustrySector Representation Scrip selection would generally take into account a
balanced sectorial representation of the listed companies in the universe of BSE
Track Record In the opinion of the BSE Index Committee the company should
have an acceptable track record
210 STOCK MARKET VOLATILITY
2101 Meaning
Volatility is a measure for variation of price of a financial instrument over time
Historic volatility is derived from time series of past market prices An implied
volatility is derived from the market price of a market traded derivative (in particular
an option) Volatility does not measure the direction of price changes merely their
dispersion This is because when calculating standard deviation (or variance) all
differences are squared so that negative and positive differences are combined into
one quantity Two instruments with different volatilities may have the same expected
return but the instrument with higher volatility will have larger swings in values over
a given period of time
For example a lower volatility stock may have an expected (average) return of 7
with annual volatility of 5 This would indicate returns from approximately negative
3 to positive 17 most of the time (19 times out of 20 or 95 via a two standard
deviation rule) A higher volatility stock with the same expected return of 7 but
with annual volatility of 20 would indicate returns from approximately negative
33 to positive 47 most of the time (19 times out of 20 or 95) These estimates
assume a normal distribution in reality stocks are found to be leptokurtotic
55
2102 Terminology used in volatility
Volatility as described here refers to the actual current volatility of a financial
instrument for a specified period (for example 30 days or 90 days) It is the volatility
of a financial instrument based on historical prices over the specified period with the
last observation the most recent price This phrase is used particularly when it is
wished to distinguish between the actual current volatility of an instrument and
actual historical volatility which refers to the volatility of a financial instrument
over a specified period but with the last observation on a date in the past
actual future volatility which refers to the volatility of a financial instrument
over a specified period starting at the current time and ending at a future date
(normally the expiry date of an options)
historical implied volatility which refers to the implied volatility observed from
historical prices of the financial instrument (normally options)
current implied volatility which refers to the implied volatility observed from
current prices of the financial instrument
future implied volatility which refers to the implied volatility observed from
future prices of the financial instrument
For a financial instrument whose price follows a random walk or wiener process the
width of the distribution increases as time increases This is because there is an
increasing profitability that the instruments price will be farther away from the initial
price as time increases However rather than increase linearly the volatility increases
with the square-root of time as time increases because some fluctuations are expected
to cancel each other out so the most likely deviation after twice the time will not be
twice the distance from zero
2103 Usefulness of volatility for Investors
Investors care about volatility for five reasons
1 The wider the swings in an investments price the harder emotionally it is to
not worry
2 Price volatility of a trading instrument can define position sizing in a portfolio
56
3 When certain cash flows from selling a security are needed at a specific future
date higher volatility means a greater chance of a shortfall
4 Higher volatility of returns while saving for retirement results in a wider
distribution of possible final portfolio values
5 Higher volatility of return when retired gives withdrawals a larger permanent
impact on the portfolios value
6 Price volatility presents opportunities to buy assets cheaply and sell when
overpriced
41
protection fund it is an amount higher than that of any exchange in the country BSE
launched a nationwide investor awareness program ―Safe Investing in the Stock
Market under which 264 programmers were held in more than 200 cities
2832 The BSE Online Trading (BOLT)
BSE on line Trading (BOLT) facilities on-line screen based trading in securities
BOLT is currently operating in 25000 trader work stations located across over 399
cities in India
2833 BSEWEBXcom
In February 2001 BSE introduced the worldlsquos first centralized exchange based
Internet trading system BSEWEBXcom This initiative enables investors anywhere
in the world to trade on BSE platform
2834 Surveillance
BSElsquos Online Surveillance System (BOSS) monitors on a real time basis the price
movements volume position and real time measurements of the default risk market
reconstruct and generation of cross market alerts
2835 BSE Training Institute
BTI imparts capital market training and certification in collaboration with reputed
management institutes and universities It offers over 40 courses on various aspects of
the capital mark and financial sector More than 20000 people have attended the BTI
program
284 Awards
Fowling awards were given to BSE
The world council of Corporate Governance has awarded the Golden Peacock
Global CSR Award for BSElsquos initiatives in corporate social responsibility
The Annual Reports and Accounts of BSE for the year ended March 312006 and
42
March 312007 have been awarded the ICAI awards for excellence in financial
reporting
The Human Resource Management at BSE has won the Asia-Pacific HRM awards
for its efforts in employer branding through talent management at work health
management at work and excellence in HR through technology
Drawing from its rich past and its equally robust performance in the recent times
BSE will continue to remain an icon in the Indian Capital Market
285 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 days closing price is taken for computation of Index closure
The use of Index Closure Algorithm prevents any intentional manipulation of the
closing index value
286 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 affect the
index values The BSE Index Cell does the day-to-day maintenance of the index
within the broad index policy framework set by the BSE Index Committee The BSE
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 BSE Index Committee comprises
of capital market expert fund managers market participants and members of the BSE
Governing Board
43
287 On-Line Computation of the Index
During trading hours value of the Index is calculated and disseminated on real time
basis This is done automatically on the basis of prices at which trades in Index
constituents are executed
288 Adjustment for Bonus Rights and Newly Issued Capital
SENSEX calculation needs to be adjusted for issue of Bonus or 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 BSE Index Cell the base value is adjusted which is used to alter
market capitalization of the component stocks to arrive at the SENSEX value The
BSE Index Cell keeps a close watch on the events that might affect the index on a
regular basis and carries out daily maintenance of all the 19 Indices
2881 Adjustments for Rights Issues
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 (ex-right) price An offsetting or
proportionate adjustment is then made to the Base Market capitalization
2882 Adjustments for Bonus Issue
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
2883 Other Issues 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
buy-back of shares corporate restructuring etc
44
289 Listing Categories
Before badla was resumed in 1996 there were only two categories of securities listed
on the BSE the specified group of shares comprising The securities in which carry
forward deals were allowed and the cash group shares in which no carry forward deals
were permitted Later it was observed that the facility of carry forward was not being
used in all the 94 scrips in the specified group Hence after badla was resumed the
size of the specified group was reduced to 32 scrips on 3 April 1996 The BSE later
decided to regroup the existing A and B group shares into three categories The BSE
delisted 637 companies for a period of 3 years during 2004-05 for non-compliance of
listing agreements
A Group This group consists of large stock with turnover and high floating stock
with large market capitalization In other words scrips with more liquidity and high
networth are included in this group At present there are 150 scrips in this group
B1 Group This group includes scrips of quality companies with equity above Rs 3
crore with high growth potential and trading frequency No carry forward facility was
allowed in this group in June 2000 there were 1803 scrips in this group
B2 Group Scrips in this group were just like those of B1 but with fortnightly
settlement However in September 1996 the BSE introduced weekly settlement for all
scrips listed on the exchange thus doing away with the distinction between the B1 and
B2 groups On June 2000 there were 3219 scrips in this group
Z Group Subsequently a Z group was introduced in 1999 with scrips of companies
that do not meet the rules regulations and stipulations laid down by the exchange It
is a buyer beware company These are some 300 scrips in the group All Z category
stocks result in delivers
F Group A new Flsquo group pertaining to debt market segment was started with effect
from 9 September 1996
S Group The BSE reduced post-public issue capital base requirement from Rs10
crore to Rs3 crore to attract listing by companies with a smaller capital base It also
45
started a new trading segment small cap stock segment known as the Slsquo segment
Corporate with minimum turnover of an equal amount would be eligible to list scrips
on this segment In addition stocks listed on the regional exchanges would also be
able to list on the lsquoSlsquo segment subject to meeting certain criteria
2810 Base Market capitalization Adjustment
The formula for adjusting the Base Market capitalization is as follows
New Base Market Capitalization (NBMC)
New Market capitalization
NBMC = Old Base Market capitalization x mdashmdashmdashmdashmdashmdashmdashmdashmdashmdashmdash
Old Market capitalization
To illustrate suppose a company issues right shares which increases the market
capitalization of the shares of that company by say Rs100 crores The existing Base
Market capitalization (Old Base Market capitalization) say is Rs2450 crores and the
aggregate market capitalization of all the shares included in the index before the right
issue is made is say Rs4781 crore The New Base Market capitalization will then
be
2450x (4781+100)
_____________________ = Rs250124 crores
4781
This figure of Rs 250124 crore will be used as the Base Market capitalization for
calculating the index number from then onwards till the next base change becomes
necessary
Index Review Frequency
The BSE 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
29 STOCK MARKET INDEX
The stock market index is the most important indices of all as it measures overall
market sentiment through a set of stocks that representative of the market The stock
46
market index is a barometer of the market behavior It reflects direction and indicates
day-to-day fluctuations in stock prices The market index reflects expectations about
the behavior of the economy as a whole It is a precursor of economic cycles The
function of a stock index is to provide investors with information regarding the
average share price in the market An ideal index must represent changes in the prices
of the scrips and reflect price movements of typical shares for better market
representation Stock index is a barometer of a nationlsquos economic health as market
prices reflect expectations about the economylsquos performance Stock indices termed as
leading economic as they indicate what is going to happen in the economy in the
future The returns generated in the stock market are based on future expectations A
good market index incorporates a set of scrips which have high market capitalization
and high liquidity Market capitalization is the sum of the market value of all the
stocks included in the index The market value is derived by multiplying the price of
the share outstanding In other words the bid-ask spread is minimum The index on a
day is calculated as the percentage of the aggregate market value of the set of scrips
incorporated in the index on that day to the average market value of the same scrips
during the base period
291 Definition of an Index
A price index is such as the stock market price of the individual securities in the
market It reflects the overall price or return movements of a group of securities
Movements in an index are determined by sample weighting and computational
procedure Sample is normally generated by random selection or try a non random
selection technique designed to incorporate desired characteristics are used to select
sample shares rather than by completely random selection Major criteria for selection
are market activity due representation to various industrial groups and to major stock
exchanges
292 Global Stock Market Indices
2921 The Dow Jones Industrial averagersquos
It is the most widely watched and quoted index because of its long existence The
Dow has 30 constituents and it follows the methodology of price based weighted
47
Changes to stocks included in the Dow are infrequent three stocks were
addeddropped in 1991 four in 1997 and four in 1999 The addition of Microsoft and
Intel in 1999 was the first inclusion of Nasdaq market stocks to the Dow 30
2922 The Nasdaq composite index
The index is the market capitalization weighted of prices for all the stocks listed in the
Nasdaq stock market The Nasdaq composite began on 8 February 1971 with a base
of 100
2923 The Nasdaq 100 index
Nasdaq 100 comprises the largest computer software and telecom stocks by market
capitalization on the Nasdaq For a company to be included in the Nasdaq 100 it must
have a minimum average trading volume of 100000 shares per day and must have
been trading on a major exchange for at least a year or two
2924 The S amp P 500 index
This index comprises 500 biggest publicly traded companies in the US by market
capitalization Most money managers treat the S amp P 500 as a proxy for the US stock
market The S amp P 500 tries to cover all major areas of US economy To be included a
company must be profitable the prospective company must not be closely hold and
must have a large trading volume for its shares
2925 The FTSE 100
The FTSE 100 consists of the largest 100 companies by full market Value listed on
the London Stock Exchange The FTSE 100 is the benchmark index to indicate the
performance of the European market It is a market capitalization weighted index that
also considers the free float weighted of individual stocks before including them in
the index
2926 The MSCI Indices
Include the MSCIEAFE (Europe Australia and Far East) MSCI Europe MSCI
world MSCI (EMF) and MSCI Pacific Basin Indices
48
The MSCI world Index is a free float adjusted market capitalization index that is
designed to measure global developed market equity performance As of April 2002
the MSCI world Index consisted of the MSCI world Index consisted of the following
23 developed market country indices
Australia Austria Belgium Canada Denmark Finland France Germany Greece
Hong Kong Ireland Italy Japan Netherlands New Zealand Norway Singapore
Portugal Spain Sweden Switzerland United Kingdom and the United States of
America
293 Methodology for Calculating The Index
2931 Price Weighted Index
In this method the price of each stock in the index is summed up which is then
equated to an index starting value An arbitrary date is set as the base and the
Laspeyerlsquos Price Index which measures price changes against a fixed base period
quantity weight is used In case of a stock split the market price of the stock falls and
these results in less weighted in the index The Dow Jones Industrial Average and
Nikkie 225 are price-weighted indices
2932 Equal Weighting
In this method each stocklsquos percentage weight in the index is equal and hence all
stocks have an equal influence on the index movement The value line index at
Kansas City Board of Trade (KCBT) is an equal weighted index
2933 Market Capitalization Weighted
29331 Full Market Capitalization Method
In this method the number of shares outstanding multiplied by the market price of a
companylsquos share determines the scriplsquos weighted in the index The shares with the
highest market capitalization would have a higher weighted and would be most
influential in this type of index Eg S amp P 500 Index in USA and S amp P CNX Nify in
India
49
29332 Modified Capitalization Weighted
This method seeks to limit the influence of the largest stocks in the index which
otherwise would dominate the entire index This method sets a limit on the largest
stock or a group of stocks The NASDAQ 100 Index is calculated by using this
method
294 Free Float Market Capitalization Method
2941 Concept
Free float methodology refers to an index construction methodology that takes in to
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 Strategic holding government 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
All BSE indices with exception of BSE-PSU index have adopted the free-float
methodology
2942 Definition of Free Float
Share holding of investor that would not in the normal course come into the
open market for trading are treated as ―Controlling Strategic Holding and
hence not included in free float specifically the following categories of
holding are generally excluded from the definition of free float
Shares hold by foundersdirectorsacquires which has control element
Shares held by person with ―Controlling Interestlsquo
Shares held by Govt as promoters
50
Holding through the FDI Route
Strategic Stakes by private corporate bodiesindividuals
Equity held by employee welfare trusts
Locked-in-shares and shares which not be sold in the open market in normal
course
2943 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-agrave-Vis an investible
index This enables an apple-to-apple comparison thereby facilitating better
evaluation of performance of active managers
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 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
The free float methodology of index construction is considered to be an industry best
practice and all major index providers like MSCI FTSE SampP 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
51
29441 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 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 055 means that only 55 of the market
capitalization of the company will be considered for index calculation
Table 24 Free-float Bands
Free-Float Free-Float Factor Free-Float Free-Float Factor
gt0 - 5 005 gt50 - 55 055
gt5 - 10 010 gt55 - 60 060
gt10 - 15 015 gt60 - 65 065
gt15 - 20 020 gt65 - 70 070
gt20 - 25 025 gt70 - 75 075
gt25 - 30 030 gt75 - 80 080
gt30 - 35 035 gt80 - 85 085
gt35 - 40 040 gt85 - 90 090
gt40 - 45 045 gt90 - 95 095
gt45 - 50 050 gt95 - 100 100
Source wwwbseindiacom
295 BSE Indices
For the premier stock exchange that pioneered the securities transaction business
in India over a century of experience is a proud achievement A lot has changed since
1875 when 318 persons by paying a then princely amount of Re 1 became members
of what today is called Bombay Stock Exchange Limited (BSE) Over the decades
the stock market in the country has passed through good and bad periods The journey
52
in the 20th century has not been an easy one Till the decade of eighties there was no
measure or scale that could precisely measure the various ups and downs in the Indian
stock market BSE in 1986 came out with a Stock Index-SENSEX- that subsequently
became the barometer of the Indian stock market
The launch of SENSEX in 1986 was later followed up in January 1989 by
introduction of BSE National Index (Base 1983-84 = 100) It comprised 100 stocks
listed at five major stock exchanges in India - Mumbai Calcutta Delhi Ahmadabad
and Madras The BSE National Index was renamed BSE-100 Index from October 14
1996 and since then it is being calculated taking into consideration only the prices of
stocks listed at BSE BSE launched the dollar-linked version of BSE-100 index on
May 22 2006
With a view to provide a better representation of the increasing number of listed
companies larger market capitalization and the new industry sectors BSE launched
on 27th May 1994 two new index series viz the BSE-200 and the DOLLEX-200
Since then BSE has come a long way in attuning itself to the varied needs of
investors and market participants In order to fulfill the need for still broader
segment-specific and sector-specific indices BSE has continuously been increasing
the range of its indices BSE-500 Index and 5 sectorial indices were launched in 1999
In 2001 BSE launched BSE-PSU Index DOLLEX-30 and the countrys first free-
float based index - the BSE TEC Index Over the years BSE shifted all its indices to
the free-float methodology
BSE disseminates information on the Price-Earnings Ratio the Price to Book Value
Ratio and the Dividend Yield Percentage on day-to-day basis of all its major indices
The values of all BSE indices are updated on real time basis during market hours and
displayed through the BOLT system BSE website and news wire agencies
All BSE Indices are reviewed periodically by the BSE Index Committee This
Committee which comprises eminent independent finance professionals frames the
broad policy guidelines for the development and maintenance of all BSE indices The
BSE Index Cell carries out the day-to-day maintenance of all indices and conducts
research on development of new indices
53
2951 BSE-100 Index
A broad-based index the BSE-100 was formerly known as the BSE National index
This Index has 1983-84 as the base year and was launched in 1989 In line with the
shift of the BSE Indices to the globally accepted Free-Float methodology BSE-100
was shifted to Free-Float methodology effective from April 5 2004 The method of
computation of Free-Float index and determination of free-float factors is similar to
the methodology for SENSEX
Table 25 Index Specification
Base Year 1983-84
Base Index Value 100
Date of Launch 3-Jan-89
Method of calculation Launched on full market capitalization
method and effective April 05 2004
calculation method shifted to free-float
market capitalization
Number of scrips 100
Index calculation frequency Real Time
Source wwwbseindiacom
2952 Base Year
The financial year 1983-84 has been chosen as the base year The price stability
during that year and proximity to the index series were the main consideration for
choice of 1983-84 as the base year The base value was fixed at 100 points
2953 Dollex-100
BSE also calculates a dollar-linked version of SENSEX and historical values of this
index are available since its inception
2954 BSE-100 index - Scrip Selection Criteria
The general guidelines for selection of constituents in BSE-100 are as follows
Trading Frequency The scrip should have been traded on 95 of the trading days
54
in the last three months Exceptions can be made for extreme reasons like scrip
suspension etc
Final Rank The scrip should figure in the top 200 companies listed by final rank
The final rank is arrived at by assigning 75 weighted to the rank on the basis of
three-month average full market capitalization and 25 weighted to the liquidity rank
based on three-month average daily turnover amp three-month average impact cost
IndustrySector Representation Scrip selection would generally take into account a
balanced sectorial representation of the listed companies in the universe of BSE
Track Record In the opinion of the BSE Index Committee the company should
have an acceptable track record
210 STOCK MARKET VOLATILITY
2101 Meaning
Volatility is a measure for variation of price of a financial instrument over time
Historic volatility is derived from time series of past market prices An implied
volatility is derived from the market price of a market traded derivative (in particular
an option) Volatility does not measure the direction of price changes merely their
dispersion This is because when calculating standard deviation (or variance) all
differences are squared so that negative and positive differences are combined into
one quantity Two instruments with different volatilities may have the same expected
return but the instrument with higher volatility will have larger swings in values over
a given period of time
For example a lower volatility stock may have an expected (average) return of 7
with annual volatility of 5 This would indicate returns from approximately negative
3 to positive 17 most of the time (19 times out of 20 or 95 via a two standard
deviation rule) A higher volatility stock with the same expected return of 7 but
with annual volatility of 20 would indicate returns from approximately negative
33 to positive 47 most of the time (19 times out of 20 or 95) These estimates
assume a normal distribution in reality stocks are found to be leptokurtotic
55
2102 Terminology used in volatility
Volatility as described here refers to the actual current volatility of a financial
instrument for a specified period (for example 30 days or 90 days) It is the volatility
of a financial instrument based on historical prices over the specified period with the
last observation the most recent price This phrase is used particularly when it is
wished to distinguish between the actual current volatility of an instrument and
actual historical volatility which refers to the volatility of a financial instrument
over a specified period but with the last observation on a date in the past
actual future volatility which refers to the volatility of a financial instrument
over a specified period starting at the current time and ending at a future date
(normally the expiry date of an options)
historical implied volatility which refers to the implied volatility observed from
historical prices of the financial instrument (normally options)
current implied volatility which refers to the implied volatility observed from
current prices of the financial instrument
future implied volatility which refers to the implied volatility observed from
future prices of the financial instrument
For a financial instrument whose price follows a random walk or wiener process the
width of the distribution increases as time increases This is because there is an
increasing profitability that the instruments price will be farther away from the initial
price as time increases However rather than increase linearly the volatility increases
with the square-root of time as time increases because some fluctuations are expected
to cancel each other out so the most likely deviation after twice the time will not be
twice the distance from zero
2103 Usefulness of volatility for Investors
Investors care about volatility for five reasons
1 The wider the swings in an investments price the harder emotionally it is to
not worry
2 Price volatility of a trading instrument can define position sizing in a portfolio
56
3 When certain cash flows from selling a security are needed at a specific future
date higher volatility means a greater chance of a shortfall
4 Higher volatility of returns while saving for retirement results in a wider
distribution of possible final portfolio values
5 Higher volatility of return when retired gives withdrawals a larger permanent
impact on the portfolios value
6 Price volatility presents opportunities to buy assets cheaply and sell when
overpriced
42
March 312007 have been awarded the ICAI awards for excellence in financial
reporting
The Human Resource Management at BSE has won the Asia-Pacific HRM awards
for its efforts in employer branding through talent management at work health
management at work and excellence in HR through technology
Drawing from its rich past and its equally robust performance in the recent times
BSE will continue to remain an icon in the Indian Capital Market
285 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 days closing price is taken for computation of Index closure
The use of Index Closure Algorithm prevents any intentional manipulation of the
closing index value
286 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 affect the
index values The BSE Index Cell does the day-to-day maintenance of the index
within the broad index policy framework set by the BSE Index Committee The BSE
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 BSE Index Committee comprises
of capital market expert fund managers market participants and members of the BSE
Governing Board
43
287 On-Line Computation of the Index
During trading hours value of the Index is calculated and disseminated on real time
basis This is done automatically on the basis of prices at which trades in Index
constituents are executed
288 Adjustment for Bonus Rights and Newly Issued Capital
SENSEX calculation needs to be adjusted for issue of Bonus or 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 BSE Index Cell the base value is adjusted which is used to alter
market capitalization of the component stocks to arrive at the SENSEX value The
BSE Index Cell keeps a close watch on the events that might affect the index on a
regular basis and carries out daily maintenance of all the 19 Indices
2881 Adjustments for Rights Issues
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 (ex-right) price An offsetting or
proportionate adjustment is then made to the Base Market capitalization
2882 Adjustments for Bonus Issue
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
2883 Other Issues 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
buy-back of shares corporate restructuring etc
44
289 Listing Categories
Before badla was resumed in 1996 there were only two categories of securities listed
on the BSE the specified group of shares comprising The securities in which carry
forward deals were allowed and the cash group shares in which no carry forward deals
were permitted Later it was observed that the facility of carry forward was not being
used in all the 94 scrips in the specified group Hence after badla was resumed the
size of the specified group was reduced to 32 scrips on 3 April 1996 The BSE later
decided to regroup the existing A and B group shares into three categories The BSE
delisted 637 companies for a period of 3 years during 2004-05 for non-compliance of
listing agreements
A Group This group consists of large stock with turnover and high floating stock
with large market capitalization In other words scrips with more liquidity and high
networth are included in this group At present there are 150 scrips in this group
B1 Group This group includes scrips of quality companies with equity above Rs 3
crore with high growth potential and trading frequency No carry forward facility was
allowed in this group in June 2000 there were 1803 scrips in this group
B2 Group Scrips in this group were just like those of B1 but with fortnightly
settlement However in September 1996 the BSE introduced weekly settlement for all
scrips listed on the exchange thus doing away with the distinction between the B1 and
B2 groups On June 2000 there were 3219 scrips in this group
Z Group Subsequently a Z group was introduced in 1999 with scrips of companies
that do not meet the rules regulations and stipulations laid down by the exchange It
is a buyer beware company These are some 300 scrips in the group All Z category
stocks result in delivers
F Group A new Flsquo group pertaining to debt market segment was started with effect
from 9 September 1996
S Group The BSE reduced post-public issue capital base requirement from Rs10
crore to Rs3 crore to attract listing by companies with a smaller capital base It also
45
started a new trading segment small cap stock segment known as the Slsquo segment
Corporate with minimum turnover of an equal amount would be eligible to list scrips
on this segment In addition stocks listed on the regional exchanges would also be
able to list on the lsquoSlsquo segment subject to meeting certain criteria
2810 Base Market capitalization Adjustment
The formula for adjusting the Base Market capitalization is as follows
New Base Market Capitalization (NBMC)
New Market capitalization
NBMC = Old Base Market capitalization x mdashmdashmdashmdashmdashmdashmdashmdashmdashmdashmdash
Old Market capitalization
To illustrate suppose a company issues right shares which increases the market
capitalization of the shares of that company by say Rs100 crores The existing Base
Market capitalization (Old Base Market capitalization) say is Rs2450 crores and the
aggregate market capitalization of all the shares included in the index before the right
issue is made is say Rs4781 crore The New Base Market capitalization will then
be
2450x (4781+100)
_____________________ = Rs250124 crores
4781
This figure of Rs 250124 crore will be used as the Base Market capitalization for
calculating the index number from then onwards till the next base change becomes
necessary
Index Review Frequency
The BSE 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
29 STOCK MARKET INDEX
The stock market index is the most important indices of all as it measures overall
market sentiment through a set of stocks that representative of the market The stock
46
market index is a barometer of the market behavior It reflects direction and indicates
day-to-day fluctuations in stock prices The market index reflects expectations about
the behavior of the economy as a whole It is a precursor of economic cycles The
function of a stock index is to provide investors with information regarding the
average share price in the market An ideal index must represent changes in the prices
of the scrips and reflect price movements of typical shares for better market
representation Stock index is a barometer of a nationlsquos economic health as market
prices reflect expectations about the economylsquos performance Stock indices termed as
leading economic as they indicate what is going to happen in the economy in the
future The returns generated in the stock market are based on future expectations A
good market index incorporates a set of scrips which have high market capitalization
and high liquidity Market capitalization is the sum of the market value of all the
stocks included in the index The market value is derived by multiplying the price of
the share outstanding In other words the bid-ask spread is minimum The index on a
day is calculated as the percentage of the aggregate market value of the set of scrips
incorporated in the index on that day to the average market value of the same scrips
during the base period
291 Definition of an Index
A price index is such as the stock market price of the individual securities in the
market It reflects the overall price or return movements of a group of securities
Movements in an index are determined by sample weighting and computational
procedure Sample is normally generated by random selection or try a non random
selection technique designed to incorporate desired characteristics are used to select
sample shares rather than by completely random selection Major criteria for selection
are market activity due representation to various industrial groups and to major stock
exchanges
292 Global Stock Market Indices
2921 The Dow Jones Industrial averagersquos
It is the most widely watched and quoted index because of its long existence The
Dow has 30 constituents and it follows the methodology of price based weighted
47
Changes to stocks included in the Dow are infrequent three stocks were
addeddropped in 1991 four in 1997 and four in 1999 The addition of Microsoft and
Intel in 1999 was the first inclusion of Nasdaq market stocks to the Dow 30
2922 The Nasdaq composite index
The index is the market capitalization weighted of prices for all the stocks listed in the
Nasdaq stock market The Nasdaq composite began on 8 February 1971 with a base
of 100
2923 The Nasdaq 100 index
Nasdaq 100 comprises the largest computer software and telecom stocks by market
capitalization on the Nasdaq For a company to be included in the Nasdaq 100 it must
have a minimum average trading volume of 100000 shares per day and must have
been trading on a major exchange for at least a year or two
2924 The S amp P 500 index
This index comprises 500 biggest publicly traded companies in the US by market
capitalization Most money managers treat the S amp P 500 as a proxy for the US stock
market The S amp P 500 tries to cover all major areas of US economy To be included a
company must be profitable the prospective company must not be closely hold and
must have a large trading volume for its shares
2925 The FTSE 100
The FTSE 100 consists of the largest 100 companies by full market Value listed on
the London Stock Exchange The FTSE 100 is the benchmark index to indicate the
performance of the European market It is a market capitalization weighted index that
also considers the free float weighted of individual stocks before including them in
the index
2926 The MSCI Indices
Include the MSCIEAFE (Europe Australia and Far East) MSCI Europe MSCI
world MSCI (EMF) and MSCI Pacific Basin Indices
48
The MSCI world Index is a free float adjusted market capitalization index that is
designed to measure global developed market equity performance As of April 2002
the MSCI world Index consisted of the MSCI world Index consisted of the following
23 developed market country indices
Australia Austria Belgium Canada Denmark Finland France Germany Greece
Hong Kong Ireland Italy Japan Netherlands New Zealand Norway Singapore
Portugal Spain Sweden Switzerland United Kingdom and the United States of
America
293 Methodology for Calculating The Index
2931 Price Weighted Index
In this method the price of each stock in the index is summed up which is then
equated to an index starting value An arbitrary date is set as the base and the
Laspeyerlsquos Price Index which measures price changes against a fixed base period
quantity weight is used In case of a stock split the market price of the stock falls and
these results in less weighted in the index The Dow Jones Industrial Average and
Nikkie 225 are price-weighted indices
2932 Equal Weighting
In this method each stocklsquos percentage weight in the index is equal and hence all
stocks have an equal influence on the index movement The value line index at
Kansas City Board of Trade (KCBT) is an equal weighted index
2933 Market Capitalization Weighted
29331 Full Market Capitalization Method
In this method the number of shares outstanding multiplied by the market price of a
companylsquos share determines the scriplsquos weighted in the index The shares with the
highest market capitalization would have a higher weighted and would be most
influential in this type of index Eg S amp P 500 Index in USA and S amp P CNX Nify in
India
49
29332 Modified Capitalization Weighted
This method seeks to limit the influence of the largest stocks in the index which
otherwise would dominate the entire index This method sets a limit on the largest
stock or a group of stocks The NASDAQ 100 Index is calculated by using this
method
294 Free Float Market Capitalization Method
2941 Concept
Free float methodology refers to an index construction methodology that takes in to
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 Strategic holding government 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
All BSE indices with exception of BSE-PSU index have adopted the free-float
methodology
2942 Definition of Free Float
Share holding of investor that would not in the normal course come into the
open market for trading are treated as ―Controlling Strategic Holding and
hence not included in free float specifically the following categories of
holding are generally excluded from the definition of free float
Shares hold by foundersdirectorsacquires which has control element
Shares held by person with ―Controlling Interestlsquo
Shares held by Govt as promoters
50
Holding through the FDI Route
Strategic Stakes by private corporate bodiesindividuals
Equity held by employee welfare trusts
Locked-in-shares and shares which not be sold in the open market in normal
course
2943 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-agrave-Vis an investible
index This enables an apple-to-apple comparison thereby facilitating better
evaluation of performance of active managers
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 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
The free float methodology of index construction is considered to be an industry best
practice and all major index providers like MSCI FTSE SampP 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
51
29441 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 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 055 means that only 55 of the market
capitalization of the company will be considered for index calculation
Table 24 Free-float Bands
Free-Float Free-Float Factor Free-Float Free-Float Factor
gt0 - 5 005 gt50 - 55 055
gt5 - 10 010 gt55 - 60 060
gt10 - 15 015 gt60 - 65 065
gt15 - 20 020 gt65 - 70 070
gt20 - 25 025 gt70 - 75 075
gt25 - 30 030 gt75 - 80 080
gt30 - 35 035 gt80 - 85 085
gt35 - 40 040 gt85 - 90 090
gt40 - 45 045 gt90 - 95 095
gt45 - 50 050 gt95 - 100 100
Source wwwbseindiacom
295 BSE Indices
For the premier stock exchange that pioneered the securities transaction business
in India over a century of experience is a proud achievement A lot has changed since
1875 when 318 persons by paying a then princely amount of Re 1 became members
of what today is called Bombay Stock Exchange Limited (BSE) Over the decades
the stock market in the country has passed through good and bad periods The journey
52
in the 20th century has not been an easy one Till the decade of eighties there was no
measure or scale that could precisely measure the various ups and downs in the Indian
stock market BSE in 1986 came out with a Stock Index-SENSEX- that subsequently
became the barometer of the Indian stock market
The launch of SENSEX in 1986 was later followed up in January 1989 by
introduction of BSE National Index (Base 1983-84 = 100) It comprised 100 stocks
listed at five major stock exchanges in India - Mumbai Calcutta Delhi Ahmadabad
and Madras The BSE National Index was renamed BSE-100 Index from October 14
1996 and since then it is being calculated taking into consideration only the prices of
stocks listed at BSE BSE launched the dollar-linked version of BSE-100 index on
May 22 2006
With a view to provide a better representation of the increasing number of listed
companies larger market capitalization and the new industry sectors BSE launched
on 27th May 1994 two new index series viz the BSE-200 and the DOLLEX-200
Since then BSE has come a long way in attuning itself to the varied needs of
investors and market participants In order to fulfill the need for still broader
segment-specific and sector-specific indices BSE has continuously been increasing
the range of its indices BSE-500 Index and 5 sectorial indices were launched in 1999
In 2001 BSE launched BSE-PSU Index DOLLEX-30 and the countrys first free-
float based index - the BSE TEC Index Over the years BSE shifted all its indices to
the free-float methodology
BSE disseminates information on the Price-Earnings Ratio the Price to Book Value
Ratio and the Dividend Yield Percentage on day-to-day basis of all its major indices
The values of all BSE indices are updated on real time basis during market hours and
displayed through the BOLT system BSE website and news wire agencies
All BSE Indices are reviewed periodically by the BSE Index Committee This
Committee which comprises eminent independent finance professionals frames the
broad policy guidelines for the development and maintenance of all BSE indices The
BSE Index Cell carries out the day-to-day maintenance of all indices and conducts
research on development of new indices
53
2951 BSE-100 Index
A broad-based index the BSE-100 was formerly known as the BSE National index
This Index has 1983-84 as the base year and was launched in 1989 In line with the
shift of the BSE Indices to the globally accepted Free-Float methodology BSE-100
was shifted to Free-Float methodology effective from April 5 2004 The method of
computation of Free-Float index and determination of free-float factors is similar to
the methodology for SENSEX
Table 25 Index Specification
Base Year 1983-84
Base Index Value 100
Date of Launch 3-Jan-89
Method of calculation Launched on full market capitalization
method and effective April 05 2004
calculation method shifted to free-float
market capitalization
Number of scrips 100
Index calculation frequency Real Time
Source wwwbseindiacom
2952 Base Year
The financial year 1983-84 has been chosen as the base year The price stability
during that year and proximity to the index series were the main consideration for
choice of 1983-84 as the base year The base value was fixed at 100 points
2953 Dollex-100
BSE also calculates a dollar-linked version of SENSEX and historical values of this
index are available since its inception
2954 BSE-100 index - Scrip Selection Criteria
The general guidelines for selection of constituents in BSE-100 are as follows
Trading Frequency The scrip should have been traded on 95 of the trading days
54
in the last three months Exceptions can be made for extreme reasons like scrip
suspension etc
Final Rank The scrip should figure in the top 200 companies listed by final rank
The final rank is arrived at by assigning 75 weighted to the rank on the basis of
three-month average full market capitalization and 25 weighted to the liquidity rank
based on three-month average daily turnover amp three-month average impact cost
IndustrySector Representation Scrip selection would generally take into account a
balanced sectorial representation of the listed companies in the universe of BSE
Track Record In the opinion of the BSE Index Committee the company should
have an acceptable track record
210 STOCK MARKET VOLATILITY
2101 Meaning
Volatility is a measure for variation of price of a financial instrument over time
Historic volatility is derived from time series of past market prices An implied
volatility is derived from the market price of a market traded derivative (in particular
an option) Volatility does not measure the direction of price changes merely their
dispersion This is because when calculating standard deviation (or variance) all
differences are squared so that negative and positive differences are combined into
one quantity Two instruments with different volatilities may have the same expected
return but the instrument with higher volatility will have larger swings in values over
a given period of time
For example a lower volatility stock may have an expected (average) return of 7
with annual volatility of 5 This would indicate returns from approximately negative
3 to positive 17 most of the time (19 times out of 20 or 95 via a two standard
deviation rule) A higher volatility stock with the same expected return of 7 but
with annual volatility of 20 would indicate returns from approximately negative
33 to positive 47 most of the time (19 times out of 20 or 95) These estimates
assume a normal distribution in reality stocks are found to be leptokurtotic
55
2102 Terminology used in volatility
Volatility as described here refers to the actual current volatility of a financial
instrument for a specified period (for example 30 days or 90 days) It is the volatility
of a financial instrument based on historical prices over the specified period with the
last observation the most recent price This phrase is used particularly when it is
wished to distinguish between the actual current volatility of an instrument and
actual historical volatility which refers to the volatility of a financial instrument
over a specified period but with the last observation on a date in the past
actual future volatility which refers to the volatility of a financial instrument
over a specified period starting at the current time and ending at a future date
(normally the expiry date of an options)
historical implied volatility which refers to the implied volatility observed from
historical prices of the financial instrument (normally options)
current implied volatility which refers to the implied volatility observed from
current prices of the financial instrument
future implied volatility which refers to the implied volatility observed from
future prices of the financial instrument
For a financial instrument whose price follows a random walk or wiener process the
width of the distribution increases as time increases This is because there is an
increasing profitability that the instruments price will be farther away from the initial
price as time increases However rather than increase linearly the volatility increases
with the square-root of time as time increases because some fluctuations are expected
to cancel each other out so the most likely deviation after twice the time will not be
twice the distance from zero
2103 Usefulness of volatility for Investors
Investors care about volatility for five reasons
1 The wider the swings in an investments price the harder emotionally it is to
not worry
2 Price volatility of a trading instrument can define position sizing in a portfolio
56
3 When certain cash flows from selling a security are needed at a specific future
date higher volatility means a greater chance of a shortfall
4 Higher volatility of returns while saving for retirement results in a wider
distribution of possible final portfolio values
5 Higher volatility of return when retired gives withdrawals a larger permanent
impact on the portfolios value
6 Price volatility presents opportunities to buy assets cheaply and sell when
overpriced
43
287 On-Line Computation of the Index
During trading hours value of the Index is calculated and disseminated on real time
basis This is done automatically on the basis of prices at which trades in Index
constituents are executed
288 Adjustment for Bonus Rights and Newly Issued Capital
SENSEX calculation needs to be adjusted for issue of Bonus or 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 BSE Index Cell the base value is adjusted which is used to alter
market capitalization of the component stocks to arrive at the SENSEX value The
BSE Index Cell keeps a close watch on the events that might affect the index on a
regular basis and carries out daily maintenance of all the 19 Indices
2881 Adjustments for Rights Issues
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 (ex-right) price An offsetting or
proportionate adjustment is then made to the Base Market capitalization
2882 Adjustments for Bonus Issue
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
2883 Other Issues 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
buy-back of shares corporate restructuring etc
44
289 Listing Categories
Before badla was resumed in 1996 there were only two categories of securities listed
on the BSE the specified group of shares comprising The securities in which carry
forward deals were allowed and the cash group shares in which no carry forward deals
were permitted Later it was observed that the facility of carry forward was not being
used in all the 94 scrips in the specified group Hence after badla was resumed the
size of the specified group was reduced to 32 scrips on 3 April 1996 The BSE later
decided to regroup the existing A and B group shares into three categories The BSE
delisted 637 companies for a period of 3 years during 2004-05 for non-compliance of
listing agreements
A Group This group consists of large stock with turnover and high floating stock
with large market capitalization In other words scrips with more liquidity and high
networth are included in this group At present there are 150 scrips in this group
B1 Group This group includes scrips of quality companies with equity above Rs 3
crore with high growth potential and trading frequency No carry forward facility was
allowed in this group in June 2000 there were 1803 scrips in this group
B2 Group Scrips in this group were just like those of B1 but with fortnightly
settlement However in September 1996 the BSE introduced weekly settlement for all
scrips listed on the exchange thus doing away with the distinction between the B1 and
B2 groups On June 2000 there were 3219 scrips in this group
Z Group Subsequently a Z group was introduced in 1999 with scrips of companies
that do not meet the rules regulations and stipulations laid down by the exchange It
is a buyer beware company These are some 300 scrips in the group All Z category
stocks result in delivers
F Group A new Flsquo group pertaining to debt market segment was started with effect
from 9 September 1996
S Group The BSE reduced post-public issue capital base requirement from Rs10
crore to Rs3 crore to attract listing by companies with a smaller capital base It also
45
started a new trading segment small cap stock segment known as the Slsquo segment
Corporate with minimum turnover of an equal amount would be eligible to list scrips
on this segment In addition stocks listed on the regional exchanges would also be
able to list on the lsquoSlsquo segment subject to meeting certain criteria
2810 Base Market capitalization Adjustment
The formula for adjusting the Base Market capitalization is as follows
New Base Market Capitalization (NBMC)
New Market capitalization
NBMC = Old Base Market capitalization x mdashmdashmdashmdashmdashmdashmdashmdashmdashmdashmdash
Old Market capitalization
To illustrate suppose a company issues right shares which increases the market
capitalization of the shares of that company by say Rs100 crores The existing Base
Market capitalization (Old Base Market capitalization) say is Rs2450 crores and the
aggregate market capitalization of all the shares included in the index before the right
issue is made is say Rs4781 crore The New Base Market capitalization will then
be
2450x (4781+100)
_____________________ = Rs250124 crores
4781
This figure of Rs 250124 crore will be used as the Base Market capitalization for
calculating the index number from then onwards till the next base change becomes
necessary
Index Review Frequency
The BSE 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
29 STOCK MARKET INDEX
The stock market index is the most important indices of all as it measures overall
market sentiment through a set of stocks that representative of the market The stock
46
market index is a barometer of the market behavior It reflects direction and indicates
day-to-day fluctuations in stock prices The market index reflects expectations about
the behavior of the economy as a whole It is a precursor of economic cycles The
function of a stock index is to provide investors with information regarding the
average share price in the market An ideal index must represent changes in the prices
of the scrips and reflect price movements of typical shares for better market
representation Stock index is a barometer of a nationlsquos economic health as market
prices reflect expectations about the economylsquos performance Stock indices termed as
leading economic as they indicate what is going to happen in the economy in the
future The returns generated in the stock market are based on future expectations A
good market index incorporates a set of scrips which have high market capitalization
and high liquidity Market capitalization is the sum of the market value of all the
stocks included in the index The market value is derived by multiplying the price of
the share outstanding In other words the bid-ask spread is minimum The index on a
day is calculated as the percentage of the aggregate market value of the set of scrips
incorporated in the index on that day to the average market value of the same scrips
during the base period
291 Definition of an Index
A price index is such as the stock market price of the individual securities in the
market It reflects the overall price or return movements of a group of securities
Movements in an index are determined by sample weighting and computational
procedure Sample is normally generated by random selection or try a non random
selection technique designed to incorporate desired characteristics are used to select
sample shares rather than by completely random selection Major criteria for selection
are market activity due representation to various industrial groups and to major stock
exchanges
292 Global Stock Market Indices
2921 The Dow Jones Industrial averagersquos
It is the most widely watched and quoted index because of its long existence The
Dow has 30 constituents and it follows the methodology of price based weighted
47
Changes to stocks included in the Dow are infrequent three stocks were
addeddropped in 1991 four in 1997 and four in 1999 The addition of Microsoft and
Intel in 1999 was the first inclusion of Nasdaq market stocks to the Dow 30
2922 The Nasdaq composite index
The index is the market capitalization weighted of prices for all the stocks listed in the
Nasdaq stock market The Nasdaq composite began on 8 February 1971 with a base
of 100
2923 The Nasdaq 100 index
Nasdaq 100 comprises the largest computer software and telecom stocks by market
capitalization on the Nasdaq For a company to be included in the Nasdaq 100 it must
have a minimum average trading volume of 100000 shares per day and must have
been trading on a major exchange for at least a year or two
2924 The S amp P 500 index
This index comprises 500 biggest publicly traded companies in the US by market
capitalization Most money managers treat the S amp P 500 as a proxy for the US stock
market The S amp P 500 tries to cover all major areas of US economy To be included a
company must be profitable the prospective company must not be closely hold and
must have a large trading volume for its shares
2925 The FTSE 100
The FTSE 100 consists of the largest 100 companies by full market Value listed on
the London Stock Exchange The FTSE 100 is the benchmark index to indicate the
performance of the European market It is a market capitalization weighted index that
also considers the free float weighted of individual stocks before including them in
the index
2926 The MSCI Indices
Include the MSCIEAFE (Europe Australia and Far East) MSCI Europe MSCI
world MSCI (EMF) and MSCI Pacific Basin Indices
48
The MSCI world Index is a free float adjusted market capitalization index that is
designed to measure global developed market equity performance As of April 2002
the MSCI world Index consisted of the MSCI world Index consisted of the following
23 developed market country indices
Australia Austria Belgium Canada Denmark Finland France Germany Greece
Hong Kong Ireland Italy Japan Netherlands New Zealand Norway Singapore
Portugal Spain Sweden Switzerland United Kingdom and the United States of
America
293 Methodology for Calculating The Index
2931 Price Weighted Index
In this method the price of each stock in the index is summed up which is then
equated to an index starting value An arbitrary date is set as the base and the
Laspeyerlsquos Price Index which measures price changes against a fixed base period
quantity weight is used In case of a stock split the market price of the stock falls and
these results in less weighted in the index The Dow Jones Industrial Average and
Nikkie 225 are price-weighted indices
2932 Equal Weighting
In this method each stocklsquos percentage weight in the index is equal and hence all
stocks have an equal influence on the index movement The value line index at
Kansas City Board of Trade (KCBT) is an equal weighted index
2933 Market Capitalization Weighted
29331 Full Market Capitalization Method
In this method the number of shares outstanding multiplied by the market price of a
companylsquos share determines the scriplsquos weighted in the index The shares with the
highest market capitalization would have a higher weighted and would be most
influential in this type of index Eg S amp P 500 Index in USA and S amp P CNX Nify in
India
49
29332 Modified Capitalization Weighted
This method seeks to limit the influence of the largest stocks in the index which
otherwise would dominate the entire index This method sets a limit on the largest
stock or a group of stocks The NASDAQ 100 Index is calculated by using this
method
294 Free Float Market Capitalization Method
2941 Concept
Free float methodology refers to an index construction methodology that takes in to
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 Strategic holding government 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
All BSE indices with exception of BSE-PSU index have adopted the free-float
methodology
2942 Definition of Free Float
Share holding of investor that would not in the normal course come into the
open market for trading are treated as ―Controlling Strategic Holding and
hence not included in free float specifically the following categories of
holding are generally excluded from the definition of free float
Shares hold by foundersdirectorsacquires which has control element
Shares held by person with ―Controlling Interestlsquo
Shares held by Govt as promoters
50
Holding through the FDI Route
Strategic Stakes by private corporate bodiesindividuals
Equity held by employee welfare trusts
Locked-in-shares and shares which not be sold in the open market in normal
course
2943 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-agrave-Vis an investible
index This enables an apple-to-apple comparison thereby facilitating better
evaluation of performance of active managers
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 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
The free float methodology of index construction is considered to be an industry best
practice and all major index providers like MSCI FTSE SampP 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
51
29441 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 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 055 means that only 55 of the market
capitalization of the company will be considered for index calculation
Table 24 Free-float Bands
Free-Float Free-Float Factor Free-Float Free-Float Factor
gt0 - 5 005 gt50 - 55 055
gt5 - 10 010 gt55 - 60 060
gt10 - 15 015 gt60 - 65 065
gt15 - 20 020 gt65 - 70 070
gt20 - 25 025 gt70 - 75 075
gt25 - 30 030 gt75 - 80 080
gt30 - 35 035 gt80 - 85 085
gt35 - 40 040 gt85 - 90 090
gt40 - 45 045 gt90 - 95 095
gt45 - 50 050 gt95 - 100 100
Source wwwbseindiacom
295 BSE Indices
For the premier stock exchange that pioneered the securities transaction business
in India over a century of experience is a proud achievement A lot has changed since
1875 when 318 persons by paying a then princely amount of Re 1 became members
of what today is called Bombay Stock Exchange Limited (BSE) Over the decades
the stock market in the country has passed through good and bad periods The journey
52
in the 20th century has not been an easy one Till the decade of eighties there was no
measure or scale that could precisely measure the various ups and downs in the Indian
stock market BSE in 1986 came out with a Stock Index-SENSEX- that subsequently
became the barometer of the Indian stock market
The launch of SENSEX in 1986 was later followed up in January 1989 by
introduction of BSE National Index (Base 1983-84 = 100) It comprised 100 stocks
listed at five major stock exchanges in India - Mumbai Calcutta Delhi Ahmadabad
and Madras The BSE National Index was renamed BSE-100 Index from October 14
1996 and since then it is being calculated taking into consideration only the prices of
stocks listed at BSE BSE launched the dollar-linked version of BSE-100 index on
May 22 2006
With a view to provide a better representation of the increasing number of listed
companies larger market capitalization and the new industry sectors BSE launched
on 27th May 1994 two new index series viz the BSE-200 and the DOLLEX-200
Since then BSE has come a long way in attuning itself to the varied needs of
investors and market participants In order to fulfill the need for still broader
segment-specific and sector-specific indices BSE has continuously been increasing
the range of its indices BSE-500 Index and 5 sectorial indices were launched in 1999
In 2001 BSE launched BSE-PSU Index DOLLEX-30 and the countrys first free-
float based index - the BSE TEC Index Over the years BSE shifted all its indices to
the free-float methodology
BSE disseminates information on the Price-Earnings Ratio the Price to Book Value
Ratio and the Dividend Yield Percentage on day-to-day basis of all its major indices
The values of all BSE indices are updated on real time basis during market hours and
displayed through the BOLT system BSE website and news wire agencies
All BSE Indices are reviewed periodically by the BSE Index Committee This
Committee which comprises eminent independent finance professionals frames the
broad policy guidelines for the development and maintenance of all BSE indices The
BSE Index Cell carries out the day-to-day maintenance of all indices and conducts
research on development of new indices
53
2951 BSE-100 Index
A broad-based index the BSE-100 was formerly known as the BSE National index
This Index has 1983-84 as the base year and was launched in 1989 In line with the
shift of the BSE Indices to the globally accepted Free-Float methodology BSE-100
was shifted to Free-Float methodology effective from April 5 2004 The method of
computation of Free-Float index and determination of free-float factors is similar to
the methodology for SENSEX
Table 25 Index Specification
Base Year 1983-84
Base Index Value 100
Date of Launch 3-Jan-89
Method of calculation Launched on full market capitalization
method and effective April 05 2004
calculation method shifted to free-float
market capitalization
Number of scrips 100
Index calculation frequency Real Time
Source wwwbseindiacom
2952 Base Year
The financial year 1983-84 has been chosen as the base year The price stability
during that year and proximity to the index series were the main consideration for
choice of 1983-84 as the base year The base value was fixed at 100 points
2953 Dollex-100
BSE also calculates a dollar-linked version of SENSEX and historical values of this
index are available since its inception
2954 BSE-100 index - Scrip Selection Criteria
The general guidelines for selection of constituents in BSE-100 are as follows
Trading Frequency The scrip should have been traded on 95 of the trading days
54
in the last three months Exceptions can be made for extreme reasons like scrip
suspension etc
Final Rank The scrip should figure in the top 200 companies listed by final rank
The final rank is arrived at by assigning 75 weighted to the rank on the basis of
three-month average full market capitalization and 25 weighted to the liquidity rank
based on three-month average daily turnover amp three-month average impact cost
IndustrySector Representation Scrip selection would generally take into account a
balanced sectorial representation of the listed companies in the universe of BSE
Track Record In the opinion of the BSE Index Committee the company should
have an acceptable track record
210 STOCK MARKET VOLATILITY
2101 Meaning
Volatility is a measure for variation of price of a financial instrument over time
Historic volatility is derived from time series of past market prices An implied
volatility is derived from the market price of a market traded derivative (in particular
an option) Volatility does not measure the direction of price changes merely their
dispersion This is because when calculating standard deviation (or variance) all
differences are squared so that negative and positive differences are combined into
one quantity Two instruments with different volatilities may have the same expected
return but the instrument with higher volatility will have larger swings in values over
a given period of time
For example a lower volatility stock may have an expected (average) return of 7
with annual volatility of 5 This would indicate returns from approximately negative
3 to positive 17 most of the time (19 times out of 20 or 95 via a two standard
deviation rule) A higher volatility stock with the same expected return of 7 but
with annual volatility of 20 would indicate returns from approximately negative
33 to positive 47 most of the time (19 times out of 20 or 95) These estimates
assume a normal distribution in reality stocks are found to be leptokurtotic
55
2102 Terminology used in volatility
Volatility as described here refers to the actual current volatility of a financial
instrument for a specified period (for example 30 days or 90 days) It is the volatility
of a financial instrument based on historical prices over the specified period with the
last observation the most recent price This phrase is used particularly when it is
wished to distinguish between the actual current volatility of an instrument and
actual historical volatility which refers to the volatility of a financial instrument
over a specified period but with the last observation on a date in the past
actual future volatility which refers to the volatility of a financial instrument
over a specified period starting at the current time and ending at a future date
(normally the expiry date of an options)
historical implied volatility which refers to the implied volatility observed from
historical prices of the financial instrument (normally options)
current implied volatility which refers to the implied volatility observed from
current prices of the financial instrument
future implied volatility which refers to the implied volatility observed from
future prices of the financial instrument
For a financial instrument whose price follows a random walk or wiener process the
width of the distribution increases as time increases This is because there is an
increasing profitability that the instruments price will be farther away from the initial
price as time increases However rather than increase linearly the volatility increases
with the square-root of time as time increases because some fluctuations are expected
to cancel each other out so the most likely deviation after twice the time will not be
twice the distance from zero
2103 Usefulness of volatility for Investors
Investors care about volatility for five reasons
1 The wider the swings in an investments price the harder emotionally it is to
not worry
2 Price volatility of a trading instrument can define position sizing in a portfolio
56
3 When certain cash flows from selling a security are needed at a specific future
date higher volatility means a greater chance of a shortfall
4 Higher volatility of returns while saving for retirement results in a wider
distribution of possible final portfolio values
5 Higher volatility of return when retired gives withdrawals a larger permanent
impact on the portfolios value
6 Price volatility presents opportunities to buy assets cheaply and sell when
overpriced
44
289 Listing Categories
Before badla was resumed in 1996 there were only two categories of securities listed
on the BSE the specified group of shares comprising The securities in which carry
forward deals were allowed and the cash group shares in which no carry forward deals
were permitted Later it was observed that the facility of carry forward was not being
used in all the 94 scrips in the specified group Hence after badla was resumed the
size of the specified group was reduced to 32 scrips on 3 April 1996 The BSE later
decided to regroup the existing A and B group shares into three categories The BSE
delisted 637 companies for a period of 3 years during 2004-05 for non-compliance of
listing agreements
A Group This group consists of large stock with turnover and high floating stock
with large market capitalization In other words scrips with more liquidity and high
networth are included in this group At present there are 150 scrips in this group
B1 Group This group includes scrips of quality companies with equity above Rs 3
crore with high growth potential and trading frequency No carry forward facility was
allowed in this group in June 2000 there were 1803 scrips in this group
B2 Group Scrips in this group were just like those of B1 but with fortnightly
settlement However in September 1996 the BSE introduced weekly settlement for all
scrips listed on the exchange thus doing away with the distinction between the B1 and
B2 groups On June 2000 there were 3219 scrips in this group
Z Group Subsequently a Z group was introduced in 1999 with scrips of companies
that do not meet the rules regulations and stipulations laid down by the exchange It
is a buyer beware company These are some 300 scrips in the group All Z category
stocks result in delivers
F Group A new Flsquo group pertaining to debt market segment was started with effect
from 9 September 1996
S Group The BSE reduced post-public issue capital base requirement from Rs10
crore to Rs3 crore to attract listing by companies with a smaller capital base It also
45
started a new trading segment small cap stock segment known as the Slsquo segment
Corporate with minimum turnover of an equal amount would be eligible to list scrips
on this segment In addition stocks listed on the regional exchanges would also be
able to list on the lsquoSlsquo segment subject to meeting certain criteria
2810 Base Market capitalization Adjustment
The formula for adjusting the Base Market capitalization is as follows
New Base Market Capitalization (NBMC)
New Market capitalization
NBMC = Old Base Market capitalization x mdashmdashmdashmdashmdashmdashmdashmdashmdashmdashmdash
Old Market capitalization
To illustrate suppose a company issues right shares which increases the market
capitalization of the shares of that company by say Rs100 crores The existing Base
Market capitalization (Old Base Market capitalization) say is Rs2450 crores and the
aggregate market capitalization of all the shares included in the index before the right
issue is made is say Rs4781 crore The New Base Market capitalization will then
be
2450x (4781+100)
_____________________ = Rs250124 crores
4781
This figure of Rs 250124 crore will be used as the Base Market capitalization for
calculating the index number from then onwards till the next base change becomes
necessary
Index Review Frequency
The BSE 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
29 STOCK MARKET INDEX
The stock market index is the most important indices of all as it measures overall
market sentiment through a set of stocks that representative of the market The stock
46
market index is a barometer of the market behavior It reflects direction and indicates
day-to-day fluctuations in stock prices The market index reflects expectations about
the behavior of the economy as a whole It is a precursor of economic cycles The
function of a stock index is to provide investors with information regarding the
average share price in the market An ideal index must represent changes in the prices
of the scrips and reflect price movements of typical shares for better market
representation Stock index is a barometer of a nationlsquos economic health as market
prices reflect expectations about the economylsquos performance Stock indices termed as
leading economic as they indicate what is going to happen in the economy in the
future The returns generated in the stock market are based on future expectations A
good market index incorporates a set of scrips which have high market capitalization
and high liquidity Market capitalization is the sum of the market value of all the
stocks included in the index The market value is derived by multiplying the price of
the share outstanding In other words the bid-ask spread is minimum The index on a
day is calculated as the percentage of the aggregate market value of the set of scrips
incorporated in the index on that day to the average market value of the same scrips
during the base period
291 Definition of an Index
A price index is such as the stock market price of the individual securities in the
market It reflects the overall price or return movements of a group of securities
Movements in an index are determined by sample weighting and computational
procedure Sample is normally generated by random selection or try a non random
selection technique designed to incorporate desired characteristics are used to select
sample shares rather than by completely random selection Major criteria for selection
are market activity due representation to various industrial groups and to major stock
exchanges
292 Global Stock Market Indices
2921 The Dow Jones Industrial averagersquos
It is the most widely watched and quoted index because of its long existence The
Dow has 30 constituents and it follows the methodology of price based weighted
47
Changes to stocks included in the Dow are infrequent three stocks were
addeddropped in 1991 four in 1997 and four in 1999 The addition of Microsoft and
Intel in 1999 was the first inclusion of Nasdaq market stocks to the Dow 30
2922 The Nasdaq composite index
The index is the market capitalization weighted of prices for all the stocks listed in the
Nasdaq stock market The Nasdaq composite began on 8 February 1971 with a base
of 100
2923 The Nasdaq 100 index
Nasdaq 100 comprises the largest computer software and telecom stocks by market
capitalization on the Nasdaq For a company to be included in the Nasdaq 100 it must
have a minimum average trading volume of 100000 shares per day and must have
been trading on a major exchange for at least a year or two
2924 The S amp P 500 index
This index comprises 500 biggest publicly traded companies in the US by market
capitalization Most money managers treat the S amp P 500 as a proxy for the US stock
market The S amp P 500 tries to cover all major areas of US economy To be included a
company must be profitable the prospective company must not be closely hold and
must have a large trading volume for its shares
2925 The FTSE 100
The FTSE 100 consists of the largest 100 companies by full market Value listed on
the London Stock Exchange The FTSE 100 is the benchmark index to indicate the
performance of the European market It is a market capitalization weighted index that
also considers the free float weighted of individual stocks before including them in
the index
2926 The MSCI Indices
Include the MSCIEAFE (Europe Australia and Far East) MSCI Europe MSCI
world MSCI (EMF) and MSCI Pacific Basin Indices
48
The MSCI world Index is a free float adjusted market capitalization index that is
designed to measure global developed market equity performance As of April 2002
the MSCI world Index consisted of the MSCI world Index consisted of the following
23 developed market country indices
Australia Austria Belgium Canada Denmark Finland France Germany Greece
Hong Kong Ireland Italy Japan Netherlands New Zealand Norway Singapore
Portugal Spain Sweden Switzerland United Kingdom and the United States of
America
293 Methodology for Calculating The Index
2931 Price Weighted Index
In this method the price of each stock in the index is summed up which is then
equated to an index starting value An arbitrary date is set as the base and the
Laspeyerlsquos Price Index which measures price changes against a fixed base period
quantity weight is used In case of a stock split the market price of the stock falls and
these results in less weighted in the index The Dow Jones Industrial Average and
Nikkie 225 are price-weighted indices
2932 Equal Weighting
In this method each stocklsquos percentage weight in the index is equal and hence all
stocks have an equal influence on the index movement The value line index at
Kansas City Board of Trade (KCBT) is an equal weighted index
2933 Market Capitalization Weighted
29331 Full Market Capitalization Method
In this method the number of shares outstanding multiplied by the market price of a
companylsquos share determines the scriplsquos weighted in the index The shares with the
highest market capitalization would have a higher weighted and would be most
influential in this type of index Eg S amp P 500 Index in USA and S amp P CNX Nify in
India
49
29332 Modified Capitalization Weighted
This method seeks to limit the influence of the largest stocks in the index which
otherwise would dominate the entire index This method sets a limit on the largest
stock or a group of stocks The NASDAQ 100 Index is calculated by using this
method
294 Free Float Market Capitalization Method
2941 Concept
Free float methodology refers to an index construction methodology that takes in to
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 Strategic holding government 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
All BSE indices with exception of BSE-PSU index have adopted the free-float
methodology
2942 Definition of Free Float
Share holding of investor that would not in the normal course come into the
open market for trading are treated as ―Controlling Strategic Holding and
hence not included in free float specifically the following categories of
holding are generally excluded from the definition of free float
Shares hold by foundersdirectorsacquires which has control element
Shares held by person with ―Controlling Interestlsquo
Shares held by Govt as promoters
50
Holding through the FDI Route
Strategic Stakes by private corporate bodiesindividuals
Equity held by employee welfare trusts
Locked-in-shares and shares which not be sold in the open market in normal
course
2943 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-agrave-Vis an investible
index This enables an apple-to-apple comparison thereby facilitating better
evaluation of performance of active managers
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 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
The free float methodology of index construction is considered to be an industry best
practice and all major index providers like MSCI FTSE SampP 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
51
29441 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 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 055 means that only 55 of the market
capitalization of the company will be considered for index calculation
Table 24 Free-float Bands
Free-Float Free-Float Factor Free-Float Free-Float Factor
gt0 - 5 005 gt50 - 55 055
gt5 - 10 010 gt55 - 60 060
gt10 - 15 015 gt60 - 65 065
gt15 - 20 020 gt65 - 70 070
gt20 - 25 025 gt70 - 75 075
gt25 - 30 030 gt75 - 80 080
gt30 - 35 035 gt80 - 85 085
gt35 - 40 040 gt85 - 90 090
gt40 - 45 045 gt90 - 95 095
gt45 - 50 050 gt95 - 100 100
Source wwwbseindiacom
295 BSE Indices
For the premier stock exchange that pioneered the securities transaction business
in India over a century of experience is a proud achievement A lot has changed since
1875 when 318 persons by paying a then princely amount of Re 1 became members
of what today is called Bombay Stock Exchange Limited (BSE) Over the decades
the stock market in the country has passed through good and bad periods The journey
52
in the 20th century has not been an easy one Till the decade of eighties there was no
measure or scale that could precisely measure the various ups and downs in the Indian
stock market BSE in 1986 came out with a Stock Index-SENSEX- that subsequently
became the barometer of the Indian stock market
The launch of SENSEX in 1986 was later followed up in January 1989 by
introduction of BSE National Index (Base 1983-84 = 100) It comprised 100 stocks
listed at five major stock exchanges in India - Mumbai Calcutta Delhi Ahmadabad
and Madras The BSE National Index was renamed BSE-100 Index from October 14
1996 and since then it is being calculated taking into consideration only the prices of
stocks listed at BSE BSE launched the dollar-linked version of BSE-100 index on
May 22 2006
With a view to provide a better representation of the increasing number of listed
companies larger market capitalization and the new industry sectors BSE launched
on 27th May 1994 two new index series viz the BSE-200 and the DOLLEX-200
Since then BSE has come a long way in attuning itself to the varied needs of
investors and market participants In order to fulfill the need for still broader
segment-specific and sector-specific indices BSE has continuously been increasing
the range of its indices BSE-500 Index and 5 sectorial indices were launched in 1999
In 2001 BSE launched BSE-PSU Index DOLLEX-30 and the countrys first free-
float based index - the BSE TEC Index Over the years BSE shifted all its indices to
the free-float methodology
BSE disseminates information on the Price-Earnings Ratio the Price to Book Value
Ratio and the Dividend Yield Percentage on day-to-day basis of all its major indices
The values of all BSE indices are updated on real time basis during market hours and
displayed through the BOLT system BSE website and news wire agencies
All BSE Indices are reviewed periodically by the BSE Index Committee This
Committee which comprises eminent independent finance professionals frames the
broad policy guidelines for the development and maintenance of all BSE indices The
BSE Index Cell carries out the day-to-day maintenance of all indices and conducts
research on development of new indices
53
2951 BSE-100 Index
A broad-based index the BSE-100 was formerly known as the BSE National index
This Index has 1983-84 as the base year and was launched in 1989 In line with the
shift of the BSE Indices to the globally accepted Free-Float methodology BSE-100
was shifted to Free-Float methodology effective from April 5 2004 The method of
computation of Free-Float index and determination of free-float factors is similar to
the methodology for SENSEX
Table 25 Index Specification
Base Year 1983-84
Base Index Value 100
Date of Launch 3-Jan-89
Method of calculation Launched on full market capitalization
method and effective April 05 2004
calculation method shifted to free-float
market capitalization
Number of scrips 100
Index calculation frequency Real Time
Source wwwbseindiacom
2952 Base Year
The financial year 1983-84 has been chosen as the base year The price stability
during that year and proximity to the index series were the main consideration for
choice of 1983-84 as the base year The base value was fixed at 100 points
2953 Dollex-100
BSE also calculates a dollar-linked version of SENSEX and historical values of this
index are available since its inception
2954 BSE-100 index - Scrip Selection Criteria
The general guidelines for selection of constituents in BSE-100 are as follows
Trading Frequency The scrip should have been traded on 95 of the trading days
54
in the last three months Exceptions can be made for extreme reasons like scrip
suspension etc
Final Rank The scrip should figure in the top 200 companies listed by final rank
The final rank is arrived at by assigning 75 weighted to the rank on the basis of
three-month average full market capitalization and 25 weighted to the liquidity rank
based on three-month average daily turnover amp three-month average impact cost
IndustrySector Representation Scrip selection would generally take into account a
balanced sectorial representation of the listed companies in the universe of BSE
Track Record In the opinion of the BSE Index Committee the company should
have an acceptable track record
210 STOCK MARKET VOLATILITY
2101 Meaning
Volatility is a measure for variation of price of a financial instrument over time
Historic volatility is derived from time series of past market prices An implied
volatility is derived from the market price of a market traded derivative (in particular
an option) Volatility does not measure the direction of price changes merely their
dispersion This is because when calculating standard deviation (or variance) all
differences are squared so that negative and positive differences are combined into
one quantity Two instruments with different volatilities may have the same expected
return but the instrument with higher volatility will have larger swings in values over
a given period of time
For example a lower volatility stock may have an expected (average) return of 7
with annual volatility of 5 This would indicate returns from approximately negative
3 to positive 17 most of the time (19 times out of 20 or 95 via a two standard
deviation rule) A higher volatility stock with the same expected return of 7 but
with annual volatility of 20 would indicate returns from approximately negative
33 to positive 47 most of the time (19 times out of 20 or 95) These estimates
assume a normal distribution in reality stocks are found to be leptokurtotic
55
2102 Terminology used in volatility
Volatility as described here refers to the actual current volatility of a financial
instrument for a specified period (for example 30 days or 90 days) It is the volatility
of a financial instrument based on historical prices over the specified period with the
last observation the most recent price This phrase is used particularly when it is
wished to distinguish between the actual current volatility of an instrument and
actual historical volatility which refers to the volatility of a financial instrument
over a specified period but with the last observation on a date in the past
actual future volatility which refers to the volatility of a financial instrument
over a specified period starting at the current time and ending at a future date
(normally the expiry date of an options)
historical implied volatility which refers to the implied volatility observed from
historical prices of the financial instrument (normally options)
current implied volatility which refers to the implied volatility observed from
current prices of the financial instrument
future implied volatility which refers to the implied volatility observed from
future prices of the financial instrument
For a financial instrument whose price follows a random walk or wiener process the
width of the distribution increases as time increases This is because there is an
increasing profitability that the instruments price will be farther away from the initial
price as time increases However rather than increase linearly the volatility increases
with the square-root of time as time increases because some fluctuations are expected
to cancel each other out so the most likely deviation after twice the time will not be
twice the distance from zero
2103 Usefulness of volatility for Investors
Investors care about volatility for five reasons
1 The wider the swings in an investments price the harder emotionally it is to
not worry
2 Price volatility of a trading instrument can define position sizing in a portfolio
56
3 When certain cash flows from selling a security are needed at a specific future
date higher volatility means a greater chance of a shortfall
4 Higher volatility of returns while saving for retirement results in a wider
distribution of possible final portfolio values
5 Higher volatility of return when retired gives withdrawals a larger permanent
impact on the portfolios value
6 Price volatility presents opportunities to buy assets cheaply and sell when
overpriced
45
started a new trading segment small cap stock segment known as the Slsquo segment
Corporate with minimum turnover of an equal amount would be eligible to list scrips
on this segment In addition stocks listed on the regional exchanges would also be
able to list on the lsquoSlsquo segment subject to meeting certain criteria
2810 Base Market capitalization Adjustment
The formula for adjusting the Base Market capitalization is as follows
New Base Market Capitalization (NBMC)
New Market capitalization
NBMC = Old Base Market capitalization x mdashmdashmdashmdashmdashmdashmdashmdashmdashmdashmdash
Old Market capitalization
To illustrate suppose a company issues right shares which increases the market
capitalization of the shares of that company by say Rs100 crores The existing Base
Market capitalization (Old Base Market capitalization) say is Rs2450 crores and the
aggregate market capitalization of all the shares included in the index before the right
issue is made is say Rs4781 crore The New Base Market capitalization will then
be
2450x (4781+100)
_____________________ = Rs250124 crores
4781
This figure of Rs 250124 crore will be used as the Base Market capitalization for
calculating the index number from then onwards till the next base change becomes
necessary
Index Review Frequency
The BSE 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
29 STOCK MARKET INDEX
The stock market index is the most important indices of all as it measures overall
market sentiment through a set of stocks that representative of the market The stock
46
market index is a barometer of the market behavior It reflects direction and indicates
day-to-day fluctuations in stock prices The market index reflects expectations about
the behavior of the economy as a whole It is a precursor of economic cycles The
function of a stock index is to provide investors with information regarding the
average share price in the market An ideal index must represent changes in the prices
of the scrips and reflect price movements of typical shares for better market
representation Stock index is a barometer of a nationlsquos economic health as market
prices reflect expectations about the economylsquos performance Stock indices termed as
leading economic as they indicate what is going to happen in the economy in the
future The returns generated in the stock market are based on future expectations A
good market index incorporates a set of scrips which have high market capitalization
and high liquidity Market capitalization is the sum of the market value of all the
stocks included in the index The market value is derived by multiplying the price of
the share outstanding In other words the bid-ask spread is minimum The index on a
day is calculated as the percentage of the aggregate market value of the set of scrips
incorporated in the index on that day to the average market value of the same scrips
during the base period
291 Definition of an Index
A price index is such as the stock market price of the individual securities in the
market It reflects the overall price or return movements of a group of securities
Movements in an index are determined by sample weighting and computational
procedure Sample is normally generated by random selection or try a non random
selection technique designed to incorporate desired characteristics are used to select
sample shares rather than by completely random selection Major criteria for selection
are market activity due representation to various industrial groups and to major stock
exchanges
292 Global Stock Market Indices
2921 The Dow Jones Industrial averagersquos
It is the most widely watched and quoted index because of its long existence The
Dow has 30 constituents and it follows the methodology of price based weighted
47
Changes to stocks included in the Dow are infrequent three stocks were
addeddropped in 1991 four in 1997 and four in 1999 The addition of Microsoft and
Intel in 1999 was the first inclusion of Nasdaq market stocks to the Dow 30
2922 The Nasdaq composite index
The index is the market capitalization weighted of prices for all the stocks listed in the
Nasdaq stock market The Nasdaq composite began on 8 February 1971 with a base
of 100
2923 The Nasdaq 100 index
Nasdaq 100 comprises the largest computer software and telecom stocks by market
capitalization on the Nasdaq For a company to be included in the Nasdaq 100 it must
have a minimum average trading volume of 100000 shares per day and must have
been trading on a major exchange for at least a year or two
2924 The S amp P 500 index
This index comprises 500 biggest publicly traded companies in the US by market
capitalization Most money managers treat the S amp P 500 as a proxy for the US stock
market The S amp P 500 tries to cover all major areas of US economy To be included a
company must be profitable the prospective company must not be closely hold and
must have a large trading volume for its shares
2925 The FTSE 100
The FTSE 100 consists of the largest 100 companies by full market Value listed on
the London Stock Exchange The FTSE 100 is the benchmark index to indicate the
performance of the European market It is a market capitalization weighted index that
also considers the free float weighted of individual stocks before including them in
the index
2926 The MSCI Indices
Include the MSCIEAFE (Europe Australia and Far East) MSCI Europe MSCI
world MSCI (EMF) and MSCI Pacific Basin Indices
48
The MSCI world Index is a free float adjusted market capitalization index that is
designed to measure global developed market equity performance As of April 2002
the MSCI world Index consisted of the MSCI world Index consisted of the following
23 developed market country indices
Australia Austria Belgium Canada Denmark Finland France Germany Greece
Hong Kong Ireland Italy Japan Netherlands New Zealand Norway Singapore
Portugal Spain Sweden Switzerland United Kingdom and the United States of
America
293 Methodology for Calculating The Index
2931 Price Weighted Index
In this method the price of each stock in the index is summed up which is then
equated to an index starting value An arbitrary date is set as the base and the
Laspeyerlsquos Price Index which measures price changes against a fixed base period
quantity weight is used In case of a stock split the market price of the stock falls and
these results in less weighted in the index The Dow Jones Industrial Average and
Nikkie 225 are price-weighted indices
2932 Equal Weighting
In this method each stocklsquos percentage weight in the index is equal and hence all
stocks have an equal influence on the index movement The value line index at
Kansas City Board of Trade (KCBT) is an equal weighted index
2933 Market Capitalization Weighted
29331 Full Market Capitalization Method
In this method the number of shares outstanding multiplied by the market price of a
companylsquos share determines the scriplsquos weighted in the index The shares with the
highest market capitalization would have a higher weighted and would be most
influential in this type of index Eg S amp P 500 Index in USA and S amp P CNX Nify in
India
49
29332 Modified Capitalization Weighted
This method seeks to limit the influence of the largest stocks in the index which
otherwise would dominate the entire index This method sets a limit on the largest
stock or a group of stocks The NASDAQ 100 Index is calculated by using this
method
294 Free Float Market Capitalization Method
2941 Concept
Free float methodology refers to an index construction methodology that takes in to
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 Strategic holding government 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
All BSE indices with exception of BSE-PSU index have adopted the free-float
methodology
2942 Definition of Free Float
Share holding of investor that would not in the normal course come into the
open market for trading are treated as ―Controlling Strategic Holding and
hence not included in free float specifically the following categories of
holding are generally excluded from the definition of free float
Shares hold by foundersdirectorsacquires which has control element
Shares held by person with ―Controlling Interestlsquo
Shares held by Govt as promoters
50
Holding through the FDI Route
Strategic Stakes by private corporate bodiesindividuals
Equity held by employee welfare trusts
Locked-in-shares and shares which not be sold in the open market in normal
course
2943 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-agrave-Vis an investible
index This enables an apple-to-apple comparison thereby facilitating better
evaluation of performance of active managers
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 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
The free float methodology of index construction is considered to be an industry best
practice and all major index providers like MSCI FTSE SampP 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
51
29441 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 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 055 means that only 55 of the market
capitalization of the company will be considered for index calculation
Table 24 Free-float Bands
Free-Float Free-Float Factor Free-Float Free-Float Factor
gt0 - 5 005 gt50 - 55 055
gt5 - 10 010 gt55 - 60 060
gt10 - 15 015 gt60 - 65 065
gt15 - 20 020 gt65 - 70 070
gt20 - 25 025 gt70 - 75 075
gt25 - 30 030 gt75 - 80 080
gt30 - 35 035 gt80 - 85 085
gt35 - 40 040 gt85 - 90 090
gt40 - 45 045 gt90 - 95 095
gt45 - 50 050 gt95 - 100 100
Source wwwbseindiacom
295 BSE Indices
For the premier stock exchange that pioneered the securities transaction business
in India over a century of experience is a proud achievement A lot has changed since
1875 when 318 persons by paying a then princely amount of Re 1 became members
of what today is called Bombay Stock Exchange Limited (BSE) Over the decades
the stock market in the country has passed through good and bad periods The journey
52
in the 20th century has not been an easy one Till the decade of eighties there was no
measure or scale that could precisely measure the various ups and downs in the Indian
stock market BSE in 1986 came out with a Stock Index-SENSEX- that subsequently
became the barometer of the Indian stock market
The launch of SENSEX in 1986 was later followed up in January 1989 by
introduction of BSE National Index (Base 1983-84 = 100) It comprised 100 stocks
listed at five major stock exchanges in India - Mumbai Calcutta Delhi Ahmadabad
and Madras The BSE National Index was renamed BSE-100 Index from October 14
1996 and since then it is being calculated taking into consideration only the prices of
stocks listed at BSE BSE launched the dollar-linked version of BSE-100 index on
May 22 2006
With a view to provide a better representation of the increasing number of listed
companies larger market capitalization and the new industry sectors BSE launched
on 27th May 1994 two new index series viz the BSE-200 and the DOLLEX-200
Since then BSE has come a long way in attuning itself to the varied needs of
investors and market participants In order to fulfill the need for still broader
segment-specific and sector-specific indices BSE has continuously been increasing
the range of its indices BSE-500 Index and 5 sectorial indices were launched in 1999
In 2001 BSE launched BSE-PSU Index DOLLEX-30 and the countrys first free-
float based index - the BSE TEC Index Over the years BSE shifted all its indices to
the free-float methodology
BSE disseminates information on the Price-Earnings Ratio the Price to Book Value
Ratio and the Dividend Yield Percentage on day-to-day basis of all its major indices
The values of all BSE indices are updated on real time basis during market hours and
displayed through the BOLT system BSE website and news wire agencies
All BSE Indices are reviewed periodically by the BSE Index Committee This
Committee which comprises eminent independent finance professionals frames the
broad policy guidelines for the development and maintenance of all BSE indices The
BSE Index Cell carries out the day-to-day maintenance of all indices and conducts
research on development of new indices
53
2951 BSE-100 Index
A broad-based index the BSE-100 was formerly known as the BSE National index
This Index has 1983-84 as the base year and was launched in 1989 In line with the
shift of the BSE Indices to the globally accepted Free-Float methodology BSE-100
was shifted to Free-Float methodology effective from April 5 2004 The method of
computation of Free-Float index and determination of free-float factors is similar to
the methodology for SENSEX
Table 25 Index Specification
Base Year 1983-84
Base Index Value 100
Date of Launch 3-Jan-89
Method of calculation Launched on full market capitalization
method and effective April 05 2004
calculation method shifted to free-float
market capitalization
Number of scrips 100
Index calculation frequency Real Time
Source wwwbseindiacom
2952 Base Year
The financial year 1983-84 has been chosen as the base year The price stability
during that year and proximity to the index series were the main consideration for
choice of 1983-84 as the base year The base value was fixed at 100 points
2953 Dollex-100
BSE also calculates a dollar-linked version of SENSEX and historical values of this
index are available since its inception
2954 BSE-100 index - Scrip Selection Criteria
The general guidelines for selection of constituents in BSE-100 are as follows
Trading Frequency The scrip should have been traded on 95 of the trading days
54
in the last three months Exceptions can be made for extreme reasons like scrip
suspension etc
Final Rank The scrip should figure in the top 200 companies listed by final rank
The final rank is arrived at by assigning 75 weighted to the rank on the basis of
three-month average full market capitalization and 25 weighted to the liquidity rank
based on three-month average daily turnover amp three-month average impact cost
IndustrySector Representation Scrip selection would generally take into account a
balanced sectorial representation of the listed companies in the universe of BSE
Track Record In the opinion of the BSE Index Committee the company should
have an acceptable track record
210 STOCK MARKET VOLATILITY
2101 Meaning
Volatility is a measure for variation of price of a financial instrument over time
Historic volatility is derived from time series of past market prices An implied
volatility is derived from the market price of a market traded derivative (in particular
an option) Volatility does not measure the direction of price changes merely their
dispersion This is because when calculating standard deviation (or variance) all
differences are squared so that negative and positive differences are combined into
one quantity Two instruments with different volatilities may have the same expected
return but the instrument with higher volatility will have larger swings in values over
a given period of time
For example a lower volatility stock may have an expected (average) return of 7
with annual volatility of 5 This would indicate returns from approximately negative
3 to positive 17 most of the time (19 times out of 20 or 95 via a two standard
deviation rule) A higher volatility stock with the same expected return of 7 but
with annual volatility of 20 would indicate returns from approximately negative
33 to positive 47 most of the time (19 times out of 20 or 95) These estimates
assume a normal distribution in reality stocks are found to be leptokurtotic
55
2102 Terminology used in volatility
Volatility as described here refers to the actual current volatility of a financial
instrument for a specified period (for example 30 days or 90 days) It is the volatility
of a financial instrument based on historical prices over the specified period with the
last observation the most recent price This phrase is used particularly when it is
wished to distinguish between the actual current volatility of an instrument and
actual historical volatility which refers to the volatility of a financial instrument
over a specified period but with the last observation on a date in the past
actual future volatility which refers to the volatility of a financial instrument
over a specified period starting at the current time and ending at a future date
(normally the expiry date of an options)
historical implied volatility which refers to the implied volatility observed from
historical prices of the financial instrument (normally options)
current implied volatility which refers to the implied volatility observed from
current prices of the financial instrument
future implied volatility which refers to the implied volatility observed from
future prices of the financial instrument
For a financial instrument whose price follows a random walk or wiener process the
width of the distribution increases as time increases This is because there is an
increasing profitability that the instruments price will be farther away from the initial
price as time increases However rather than increase linearly the volatility increases
with the square-root of time as time increases because some fluctuations are expected
to cancel each other out so the most likely deviation after twice the time will not be
twice the distance from zero
2103 Usefulness of volatility for Investors
Investors care about volatility for five reasons
1 The wider the swings in an investments price the harder emotionally it is to
not worry
2 Price volatility of a trading instrument can define position sizing in a portfolio
56
3 When certain cash flows from selling a security are needed at a specific future
date higher volatility means a greater chance of a shortfall
4 Higher volatility of returns while saving for retirement results in a wider
distribution of possible final portfolio values
5 Higher volatility of return when retired gives withdrawals a larger permanent
impact on the portfolios value
6 Price volatility presents opportunities to buy assets cheaply and sell when
overpriced
46
market index is a barometer of the market behavior It reflects direction and indicates
day-to-day fluctuations in stock prices The market index reflects expectations about
the behavior of the economy as a whole It is a precursor of economic cycles The
function of a stock index is to provide investors with information regarding the
average share price in the market An ideal index must represent changes in the prices
of the scrips and reflect price movements of typical shares for better market
representation Stock index is a barometer of a nationlsquos economic health as market
prices reflect expectations about the economylsquos performance Stock indices termed as
leading economic as they indicate what is going to happen in the economy in the
future The returns generated in the stock market are based on future expectations A
good market index incorporates a set of scrips which have high market capitalization
and high liquidity Market capitalization is the sum of the market value of all the
stocks included in the index The market value is derived by multiplying the price of
the share outstanding In other words the bid-ask spread is minimum The index on a
day is calculated as the percentage of the aggregate market value of the set of scrips
incorporated in the index on that day to the average market value of the same scrips
during the base period
291 Definition of an Index
A price index is such as the stock market price of the individual securities in the
market It reflects the overall price or return movements of a group of securities
Movements in an index are determined by sample weighting and computational
procedure Sample is normally generated by random selection or try a non random
selection technique designed to incorporate desired characteristics are used to select
sample shares rather than by completely random selection Major criteria for selection
are market activity due representation to various industrial groups and to major stock
exchanges
292 Global Stock Market Indices
2921 The Dow Jones Industrial averagersquos
It is the most widely watched and quoted index because of its long existence The
Dow has 30 constituents and it follows the methodology of price based weighted
47
Changes to stocks included in the Dow are infrequent three stocks were
addeddropped in 1991 four in 1997 and four in 1999 The addition of Microsoft and
Intel in 1999 was the first inclusion of Nasdaq market stocks to the Dow 30
2922 The Nasdaq composite index
The index is the market capitalization weighted of prices for all the stocks listed in the
Nasdaq stock market The Nasdaq composite began on 8 February 1971 with a base
of 100
2923 The Nasdaq 100 index
Nasdaq 100 comprises the largest computer software and telecom stocks by market
capitalization on the Nasdaq For a company to be included in the Nasdaq 100 it must
have a minimum average trading volume of 100000 shares per day and must have
been trading on a major exchange for at least a year or two
2924 The S amp P 500 index
This index comprises 500 biggest publicly traded companies in the US by market
capitalization Most money managers treat the S amp P 500 as a proxy for the US stock
market The S amp P 500 tries to cover all major areas of US economy To be included a
company must be profitable the prospective company must not be closely hold and
must have a large trading volume for its shares
2925 The FTSE 100
The FTSE 100 consists of the largest 100 companies by full market Value listed on
the London Stock Exchange The FTSE 100 is the benchmark index to indicate the
performance of the European market It is a market capitalization weighted index that
also considers the free float weighted of individual stocks before including them in
the index
2926 The MSCI Indices
Include the MSCIEAFE (Europe Australia and Far East) MSCI Europe MSCI
world MSCI (EMF) and MSCI Pacific Basin Indices
48
The MSCI world Index is a free float adjusted market capitalization index that is
designed to measure global developed market equity performance As of April 2002
the MSCI world Index consisted of the MSCI world Index consisted of the following
23 developed market country indices
Australia Austria Belgium Canada Denmark Finland France Germany Greece
Hong Kong Ireland Italy Japan Netherlands New Zealand Norway Singapore
Portugal Spain Sweden Switzerland United Kingdom and the United States of
America
293 Methodology for Calculating The Index
2931 Price Weighted Index
In this method the price of each stock in the index is summed up which is then
equated to an index starting value An arbitrary date is set as the base and the
Laspeyerlsquos Price Index which measures price changes against a fixed base period
quantity weight is used In case of a stock split the market price of the stock falls and
these results in less weighted in the index The Dow Jones Industrial Average and
Nikkie 225 are price-weighted indices
2932 Equal Weighting
In this method each stocklsquos percentage weight in the index is equal and hence all
stocks have an equal influence on the index movement The value line index at
Kansas City Board of Trade (KCBT) is an equal weighted index
2933 Market Capitalization Weighted
29331 Full Market Capitalization Method
In this method the number of shares outstanding multiplied by the market price of a
companylsquos share determines the scriplsquos weighted in the index The shares with the
highest market capitalization would have a higher weighted and would be most
influential in this type of index Eg S amp P 500 Index in USA and S amp P CNX Nify in
India
49
29332 Modified Capitalization Weighted
This method seeks to limit the influence of the largest stocks in the index which
otherwise would dominate the entire index This method sets a limit on the largest
stock or a group of stocks The NASDAQ 100 Index is calculated by using this
method
294 Free Float Market Capitalization Method
2941 Concept
Free float methodology refers to an index construction methodology that takes in to
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 Strategic holding government 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
All BSE indices with exception of BSE-PSU index have adopted the free-float
methodology
2942 Definition of Free Float
Share holding of investor that would not in the normal course come into the
open market for trading are treated as ―Controlling Strategic Holding and
hence not included in free float specifically the following categories of
holding are generally excluded from the definition of free float
Shares hold by foundersdirectorsacquires which has control element
Shares held by person with ―Controlling Interestlsquo
Shares held by Govt as promoters
50
Holding through the FDI Route
Strategic Stakes by private corporate bodiesindividuals
Equity held by employee welfare trusts
Locked-in-shares and shares which not be sold in the open market in normal
course
2943 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-agrave-Vis an investible
index This enables an apple-to-apple comparison thereby facilitating better
evaluation of performance of active managers
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 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
The free float methodology of index construction is considered to be an industry best
practice and all major index providers like MSCI FTSE SampP 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
51
29441 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 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 055 means that only 55 of the market
capitalization of the company will be considered for index calculation
Table 24 Free-float Bands
Free-Float Free-Float Factor Free-Float Free-Float Factor
gt0 - 5 005 gt50 - 55 055
gt5 - 10 010 gt55 - 60 060
gt10 - 15 015 gt60 - 65 065
gt15 - 20 020 gt65 - 70 070
gt20 - 25 025 gt70 - 75 075
gt25 - 30 030 gt75 - 80 080
gt30 - 35 035 gt80 - 85 085
gt35 - 40 040 gt85 - 90 090
gt40 - 45 045 gt90 - 95 095
gt45 - 50 050 gt95 - 100 100
Source wwwbseindiacom
295 BSE Indices
For the premier stock exchange that pioneered the securities transaction business
in India over a century of experience is a proud achievement A lot has changed since
1875 when 318 persons by paying a then princely amount of Re 1 became members
of what today is called Bombay Stock Exchange Limited (BSE) Over the decades
the stock market in the country has passed through good and bad periods The journey
52
in the 20th century has not been an easy one Till the decade of eighties there was no
measure or scale that could precisely measure the various ups and downs in the Indian
stock market BSE in 1986 came out with a Stock Index-SENSEX- that subsequently
became the barometer of the Indian stock market
The launch of SENSEX in 1986 was later followed up in January 1989 by
introduction of BSE National Index (Base 1983-84 = 100) It comprised 100 stocks
listed at five major stock exchanges in India - Mumbai Calcutta Delhi Ahmadabad
and Madras The BSE National Index was renamed BSE-100 Index from October 14
1996 and since then it is being calculated taking into consideration only the prices of
stocks listed at BSE BSE launched the dollar-linked version of BSE-100 index on
May 22 2006
With a view to provide a better representation of the increasing number of listed
companies larger market capitalization and the new industry sectors BSE launched
on 27th May 1994 two new index series viz the BSE-200 and the DOLLEX-200
Since then BSE has come a long way in attuning itself to the varied needs of
investors and market participants In order to fulfill the need for still broader
segment-specific and sector-specific indices BSE has continuously been increasing
the range of its indices BSE-500 Index and 5 sectorial indices were launched in 1999
In 2001 BSE launched BSE-PSU Index DOLLEX-30 and the countrys first free-
float based index - the BSE TEC Index Over the years BSE shifted all its indices to
the free-float methodology
BSE disseminates information on the Price-Earnings Ratio the Price to Book Value
Ratio and the Dividend Yield Percentage on day-to-day basis of all its major indices
The values of all BSE indices are updated on real time basis during market hours and
displayed through the BOLT system BSE website and news wire agencies
All BSE Indices are reviewed periodically by the BSE Index Committee This
Committee which comprises eminent independent finance professionals frames the
broad policy guidelines for the development and maintenance of all BSE indices The
BSE Index Cell carries out the day-to-day maintenance of all indices and conducts
research on development of new indices
53
2951 BSE-100 Index
A broad-based index the BSE-100 was formerly known as the BSE National index
This Index has 1983-84 as the base year and was launched in 1989 In line with the
shift of the BSE Indices to the globally accepted Free-Float methodology BSE-100
was shifted to Free-Float methodology effective from April 5 2004 The method of
computation of Free-Float index and determination of free-float factors is similar to
the methodology for SENSEX
Table 25 Index Specification
Base Year 1983-84
Base Index Value 100
Date of Launch 3-Jan-89
Method of calculation Launched on full market capitalization
method and effective April 05 2004
calculation method shifted to free-float
market capitalization
Number of scrips 100
Index calculation frequency Real Time
Source wwwbseindiacom
2952 Base Year
The financial year 1983-84 has been chosen as the base year The price stability
during that year and proximity to the index series were the main consideration for
choice of 1983-84 as the base year The base value was fixed at 100 points
2953 Dollex-100
BSE also calculates a dollar-linked version of SENSEX and historical values of this
index are available since its inception
2954 BSE-100 index - Scrip Selection Criteria
The general guidelines for selection of constituents in BSE-100 are as follows
Trading Frequency The scrip should have been traded on 95 of the trading days
54
in the last three months Exceptions can be made for extreme reasons like scrip
suspension etc
Final Rank The scrip should figure in the top 200 companies listed by final rank
The final rank is arrived at by assigning 75 weighted to the rank on the basis of
three-month average full market capitalization and 25 weighted to the liquidity rank
based on three-month average daily turnover amp three-month average impact cost
IndustrySector Representation Scrip selection would generally take into account a
balanced sectorial representation of the listed companies in the universe of BSE
Track Record In the opinion of the BSE Index Committee the company should
have an acceptable track record
210 STOCK MARKET VOLATILITY
2101 Meaning
Volatility is a measure for variation of price of a financial instrument over time
Historic volatility is derived from time series of past market prices An implied
volatility is derived from the market price of a market traded derivative (in particular
an option) Volatility does not measure the direction of price changes merely their
dispersion This is because when calculating standard deviation (or variance) all
differences are squared so that negative and positive differences are combined into
one quantity Two instruments with different volatilities may have the same expected
return but the instrument with higher volatility will have larger swings in values over
a given period of time
For example a lower volatility stock may have an expected (average) return of 7
with annual volatility of 5 This would indicate returns from approximately negative
3 to positive 17 most of the time (19 times out of 20 or 95 via a two standard
deviation rule) A higher volatility stock with the same expected return of 7 but
with annual volatility of 20 would indicate returns from approximately negative
33 to positive 47 most of the time (19 times out of 20 or 95) These estimates
assume a normal distribution in reality stocks are found to be leptokurtotic
55
2102 Terminology used in volatility
Volatility as described here refers to the actual current volatility of a financial
instrument for a specified period (for example 30 days or 90 days) It is the volatility
of a financial instrument based on historical prices over the specified period with the
last observation the most recent price This phrase is used particularly when it is
wished to distinguish between the actual current volatility of an instrument and
actual historical volatility which refers to the volatility of a financial instrument
over a specified period but with the last observation on a date in the past
actual future volatility which refers to the volatility of a financial instrument
over a specified period starting at the current time and ending at a future date
(normally the expiry date of an options)
historical implied volatility which refers to the implied volatility observed from
historical prices of the financial instrument (normally options)
current implied volatility which refers to the implied volatility observed from
current prices of the financial instrument
future implied volatility which refers to the implied volatility observed from
future prices of the financial instrument
For a financial instrument whose price follows a random walk or wiener process the
width of the distribution increases as time increases This is because there is an
increasing profitability that the instruments price will be farther away from the initial
price as time increases However rather than increase linearly the volatility increases
with the square-root of time as time increases because some fluctuations are expected
to cancel each other out so the most likely deviation after twice the time will not be
twice the distance from zero
2103 Usefulness of volatility for Investors
Investors care about volatility for five reasons
1 The wider the swings in an investments price the harder emotionally it is to
not worry
2 Price volatility of a trading instrument can define position sizing in a portfolio
56
3 When certain cash flows from selling a security are needed at a specific future
date higher volatility means a greater chance of a shortfall
4 Higher volatility of returns while saving for retirement results in a wider
distribution of possible final portfolio values
5 Higher volatility of return when retired gives withdrawals a larger permanent
impact on the portfolios value
6 Price volatility presents opportunities to buy assets cheaply and sell when
overpriced
47
Changes to stocks included in the Dow are infrequent three stocks were
addeddropped in 1991 four in 1997 and four in 1999 The addition of Microsoft and
Intel in 1999 was the first inclusion of Nasdaq market stocks to the Dow 30
2922 The Nasdaq composite index
The index is the market capitalization weighted of prices for all the stocks listed in the
Nasdaq stock market The Nasdaq composite began on 8 February 1971 with a base
of 100
2923 The Nasdaq 100 index
Nasdaq 100 comprises the largest computer software and telecom stocks by market
capitalization on the Nasdaq For a company to be included in the Nasdaq 100 it must
have a minimum average trading volume of 100000 shares per day and must have
been trading on a major exchange for at least a year or two
2924 The S amp P 500 index
This index comprises 500 biggest publicly traded companies in the US by market
capitalization Most money managers treat the S amp P 500 as a proxy for the US stock
market The S amp P 500 tries to cover all major areas of US economy To be included a
company must be profitable the prospective company must not be closely hold and
must have a large trading volume for its shares
2925 The FTSE 100
The FTSE 100 consists of the largest 100 companies by full market Value listed on
the London Stock Exchange The FTSE 100 is the benchmark index to indicate the
performance of the European market It is a market capitalization weighted index that
also considers the free float weighted of individual stocks before including them in
the index
2926 The MSCI Indices
Include the MSCIEAFE (Europe Australia and Far East) MSCI Europe MSCI
world MSCI (EMF) and MSCI Pacific Basin Indices
48
The MSCI world Index is a free float adjusted market capitalization index that is
designed to measure global developed market equity performance As of April 2002
the MSCI world Index consisted of the MSCI world Index consisted of the following
23 developed market country indices
Australia Austria Belgium Canada Denmark Finland France Germany Greece
Hong Kong Ireland Italy Japan Netherlands New Zealand Norway Singapore
Portugal Spain Sweden Switzerland United Kingdom and the United States of
America
293 Methodology for Calculating The Index
2931 Price Weighted Index
In this method the price of each stock in the index is summed up which is then
equated to an index starting value An arbitrary date is set as the base and the
Laspeyerlsquos Price Index which measures price changes against a fixed base period
quantity weight is used In case of a stock split the market price of the stock falls and
these results in less weighted in the index The Dow Jones Industrial Average and
Nikkie 225 are price-weighted indices
2932 Equal Weighting
In this method each stocklsquos percentage weight in the index is equal and hence all
stocks have an equal influence on the index movement The value line index at
Kansas City Board of Trade (KCBT) is an equal weighted index
2933 Market Capitalization Weighted
29331 Full Market Capitalization Method
In this method the number of shares outstanding multiplied by the market price of a
companylsquos share determines the scriplsquos weighted in the index The shares with the
highest market capitalization would have a higher weighted and would be most
influential in this type of index Eg S amp P 500 Index in USA and S amp P CNX Nify in
India
49
29332 Modified Capitalization Weighted
This method seeks to limit the influence of the largest stocks in the index which
otherwise would dominate the entire index This method sets a limit on the largest
stock or a group of stocks The NASDAQ 100 Index is calculated by using this
method
294 Free Float Market Capitalization Method
2941 Concept
Free float methodology refers to an index construction methodology that takes in to
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 Strategic holding government 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
All BSE indices with exception of BSE-PSU index have adopted the free-float
methodology
2942 Definition of Free Float
Share holding of investor that would not in the normal course come into the
open market for trading are treated as ―Controlling Strategic Holding and
hence not included in free float specifically the following categories of
holding are generally excluded from the definition of free float
Shares hold by foundersdirectorsacquires which has control element
Shares held by person with ―Controlling Interestlsquo
Shares held by Govt as promoters
50
Holding through the FDI Route
Strategic Stakes by private corporate bodiesindividuals
Equity held by employee welfare trusts
Locked-in-shares and shares which not be sold in the open market in normal
course
2943 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-agrave-Vis an investible
index This enables an apple-to-apple comparison thereby facilitating better
evaluation of performance of active managers
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 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
The free float methodology of index construction is considered to be an industry best
practice and all major index providers like MSCI FTSE SampP 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
51
29441 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 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 055 means that only 55 of the market
capitalization of the company will be considered for index calculation
Table 24 Free-float Bands
Free-Float Free-Float Factor Free-Float Free-Float Factor
gt0 - 5 005 gt50 - 55 055
gt5 - 10 010 gt55 - 60 060
gt10 - 15 015 gt60 - 65 065
gt15 - 20 020 gt65 - 70 070
gt20 - 25 025 gt70 - 75 075
gt25 - 30 030 gt75 - 80 080
gt30 - 35 035 gt80 - 85 085
gt35 - 40 040 gt85 - 90 090
gt40 - 45 045 gt90 - 95 095
gt45 - 50 050 gt95 - 100 100
Source wwwbseindiacom
295 BSE Indices
For the premier stock exchange that pioneered the securities transaction business
in India over a century of experience is a proud achievement A lot has changed since
1875 when 318 persons by paying a then princely amount of Re 1 became members
of what today is called Bombay Stock Exchange Limited (BSE) Over the decades
the stock market in the country has passed through good and bad periods The journey
52
in the 20th century has not been an easy one Till the decade of eighties there was no
measure or scale that could precisely measure the various ups and downs in the Indian
stock market BSE in 1986 came out with a Stock Index-SENSEX- that subsequently
became the barometer of the Indian stock market
The launch of SENSEX in 1986 was later followed up in January 1989 by
introduction of BSE National Index (Base 1983-84 = 100) It comprised 100 stocks
listed at five major stock exchanges in India - Mumbai Calcutta Delhi Ahmadabad
and Madras The BSE National Index was renamed BSE-100 Index from October 14
1996 and since then it is being calculated taking into consideration only the prices of
stocks listed at BSE BSE launched the dollar-linked version of BSE-100 index on
May 22 2006
With a view to provide a better representation of the increasing number of listed
companies larger market capitalization and the new industry sectors BSE launched
on 27th May 1994 two new index series viz the BSE-200 and the DOLLEX-200
Since then BSE has come a long way in attuning itself to the varied needs of
investors and market participants In order to fulfill the need for still broader
segment-specific and sector-specific indices BSE has continuously been increasing
the range of its indices BSE-500 Index and 5 sectorial indices were launched in 1999
In 2001 BSE launched BSE-PSU Index DOLLEX-30 and the countrys first free-
float based index - the BSE TEC Index Over the years BSE shifted all its indices to
the free-float methodology
BSE disseminates information on the Price-Earnings Ratio the Price to Book Value
Ratio and the Dividend Yield Percentage on day-to-day basis of all its major indices
The values of all BSE indices are updated on real time basis during market hours and
displayed through the BOLT system BSE website and news wire agencies
All BSE Indices are reviewed periodically by the BSE Index Committee This
Committee which comprises eminent independent finance professionals frames the
broad policy guidelines for the development and maintenance of all BSE indices The
BSE Index Cell carries out the day-to-day maintenance of all indices and conducts
research on development of new indices
53
2951 BSE-100 Index
A broad-based index the BSE-100 was formerly known as the BSE National index
This Index has 1983-84 as the base year and was launched in 1989 In line with the
shift of the BSE Indices to the globally accepted Free-Float methodology BSE-100
was shifted to Free-Float methodology effective from April 5 2004 The method of
computation of Free-Float index and determination of free-float factors is similar to
the methodology for SENSEX
Table 25 Index Specification
Base Year 1983-84
Base Index Value 100
Date of Launch 3-Jan-89
Method of calculation Launched on full market capitalization
method and effective April 05 2004
calculation method shifted to free-float
market capitalization
Number of scrips 100
Index calculation frequency Real Time
Source wwwbseindiacom
2952 Base Year
The financial year 1983-84 has been chosen as the base year The price stability
during that year and proximity to the index series were the main consideration for
choice of 1983-84 as the base year The base value was fixed at 100 points
2953 Dollex-100
BSE also calculates a dollar-linked version of SENSEX and historical values of this
index are available since its inception
2954 BSE-100 index - Scrip Selection Criteria
The general guidelines for selection of constituents in BSE-100 are as follows
Trading Frequency The scrip should have been traded on 95 of the trading days
54
in the last three months Exceptions can be made for extreme reasons like scrip
suspension etc
Final Rank The scrip should figure in the top 200 companies listed by final rank
The final rank is arrived at by assigning 75 weighted to the rank on the basis of
three-month average full market capitalization and 25 weighted to the liquidity rank
based on three-month average daily turnover amp three-month average impact cost
IndustrySector Representation Scrip selection would generally take into account a
balanced sectorial representation of the listed companies in the universe of BSE
Track Record In the opinion of the BSE Index Committee the company should
have an acceptable track record
210 STOCK MARKET VOLATILITY
2101 Meaning
Volatility is a measure for variation of price of a financial instrument over time
Historic volatility is derived from time series of past market prices An implied
volatility is derived from the market price of a market traded derivative (in particular
an option) Volatility does not measure the direction of price changes merely their
dispersion This is because when calculating standard deviation (or variance) all
differences are squared so that negative and positive differences are combined into
one quantity Two instruments with different volatilities may have the same expected
return but the instrument with higher volatility will have larger swings in values over
a given period of time
For example a lower volatility stock may have an expected (average) return of 7
with annual volatility of 5 This would indicate returns from approximately negative
3 to positive 17 most of the time (19 times out of 20 or 95 via a two standard
deviation rule) A higher volatility stock with the same expected return of 7 but
with annual volatility of 20 would indicate returns from approximately negative
33 to positive 47 most of the time (19 times out of 20 or 95) These estimates
assume a normal distribution in reality stocks are found to be leptokurtotic
55
2102 Terminology used in volatility
Volatility as described here refers to the actual current volatility of a financial
instrument for a specified period (for example 30 days or 90 days) It is the volatility
of a financial instrument based on historical prices over the specified period with the
last observation the most recent price This phrase is used particularly when it is
wished to distinguish between the actual current volatility of an instrument and
actual historical volatility which refers to the volatility of a financial instrument
over a specified period but with the last observation on a date in the past
actual future volatility which refers to the volatility of a financial instrument
over a specified period starting at the current time and ending at a future date
(normally the expiry date of an options)
historical implied volatility which refers to the implied volatility observed from
historical prices of the financial instrument (normally options)
current implied volatility which refers to the implied volatility observed from
current prices of the financial instrument
future implied volatility which refers to the implied volatility observed from
future prices of the financial instrument
For a financial instrument whose price follows a random walk or wiener process the
width of the distribution increases as time increases This is because there is an
increasing profitability that the instruments price will be farther away from the initial
price as time increases However rather than increase linearly the volatility increases
with the square-root of time as time increases because some fluctuations are expected
to cancel each other out so the most likely deviation after twice the time will not be
twice the distance from zero
2103 Usefulness of volatility for Investors
Investors care about volatility for five reasons
1 The wider the swings in an investments price the harder emotionally it is to
not worry
2 Price volatility of a trading instrument can define position sizing in a portfolio
56
3 When certain cash flows from selling a security are needed at a specific future
date higher volatility means a greater chance of a shortfall
4 Higher volatility of returns while saving for retirement results in a wider
distribution of possible final portfolio values
5 Higher volatility of return when retired gives withdrawals a larger permanent
impact on the portfolios value
6 Price volatility presents opportunities to buy assets cheaply and sell when
overpriced
48
The MSCI world Index is a free float adjusted market capitalization index that is
designed to measure global developed market equity performance As of April 2002
the MSCI world Index consisted of the MSCI world Index consisted of the following
23 developed market country indices
Australia Austria Belgium Canada Denmark Finland France Germany Greece
Hong Kong Ireland Italy Japan Netherlands New Zealand Norway Singapore
Portugal Spain Sweden Switzerland United Kingdom and the United States of
America
293 Methodology for Calculating The Index
2931 Price Weighted Index
In this method the price of each stock in the index is summed up which is then
equated to an index starting value An arbitrary date is set as the base and the
Laspeyerlsquos Price Index which measures price changes against a fixed base period
quantity weight is used In case of a stock split the market price of the stock falls and
these results in less weighted in the index The Dow Jones Industrial Average and
Nikkie 225 are price-weighted indices
2932 Equal Weighting
In this method each stocklsquos percentage weight in the index is equal and hence all
stocks have an equal influence on the index movement The value line index at
Kansas City Board of Trade (KCBT) is an equal weighted index
2933 Market Capitalization Weighted
29331 Full Market Capitalization Method
In this method the number of shares outstanding multiplied by the market price of a
companylsquos share determines the scriplsquos weighted in the index The shares with the
highest market capitalization would have a higher weighted and would be most
influential in this type of index Eg S amp P 500 Index in USA and S amp P CNX Nify in
India
49
29332 Modified Capitalization Weighted
This method seeks to limit the influence of the largest stocks in the index which
otherwise would dominate the entire index This method sets a limit on the largest
stock or a group of stocks The NASDAQ 100 Index is calculated by using this
method
294 Free Float Market Capitalization Method
2941 Concept
Free float methodology refers to an index construction methodology that takes in to
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 Strategic holding government 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
All BSE indices with exception of BSE-PSU index have adopted the free-float
methodology
2942 Definition of Free Float
Share holding of investor that would not in the normal course come into the
open market for trading are treated as ―Controlling Strategic Holding and
hence not included in free float specifically the following categories of
holding are generally excluded from the definition of free float
Shares hold by foundersdirectorsacquires which has control element
Shares held by person with ―Controlling Interestlsquo
Shares held by Govt as promoters
50
Holding through the FDI Route
Strategic Stakes by private corporate bodiesindividuals
Equity held by employee welfare trusts
Locked-in-shares and shares which not be sold in the open market in normal
course
2943 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-agrave-Vis an investible
index This enables an apple-to-apple comparison thereby facilitating better
evaluation of performance of active managers
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 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
The free float methodology of index construction is considered to be an industry best
practice and all major index providers like MSCI FTSE SampP 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
51
29441 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 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 055 means that only 55 of the market
capitalization of the company will be considered for index calculation
Table 24 Free-float Bands
Free-Float Free-Float Factor Free-Float Free-Float Factor
gt0 - 5 005 gt50 - 55 055
gt5 - 10 010 gt55 - 60 060
gt10 - 15 015 gt60 - 65 065
gt15 - 20 020 gt65 - 70 070
gt20 - 25 025 gt70 - 75 075
gt25 - 30 030 gt75 - 80 080
gt30 - 35 035 gt80 - 85 085
gt35 - 40 040 gt85 - 90 090
gt40 - 45 045 gt90 - 95 095
gt45 - 50 050 gt95 - 100 100
Source wwwbseindiacom
295 BSE Indices
For the premier stock exchange that pioneered the securities transaction business
in India over a century of experience is a proud achievement A lot has changed since
1875 when 318 persons by paying a then princely amount of Re 1 became members
of what today is called Bombay Stock Exchange Limited (BSE) Over the decades
the stock market in the country has passed through good and bad periods The journey
52
in the 20th century has not been an easy one Till the decade of eighties there was no
measure or scale that could precisely measure the various ups and downs in the Indian
stock market BSE in 1986 came out with a Stock Index-SENSEX- that subsequently
became the barometer of the Indian stock market
The launch of SENSEX in 1986 was later followed up in January 1989 by
introduction of BSE National Index (Base 1983-84 = 100) It comprised 100 stocks
listed at five major stock exchanges in India - Mumbai Calcutta Delhi Ahmadabad
and Madras The BSE National Index was renamed BSE-100 Index from October 14
1996 and since then it is being calculated taking into consideration only the prices of
stocks listed at BSE BSE launched the dollar-linked version of BSE-100 index on
May 22 2006
With a view to provide a better representation of the increasing number of listed
companies larger market capitalization and the new industry sectors BSE launched
on 27th May 1994 two new index series viz the BSE-200 and the DOLLEX-200
Since then BSE has come a long way in attuning itself to the varied needs of
investors and market participants In order to fulfill the need for still broader
segment-specific and sector-specific indices BSE has continuously been increasing
the range of its indices BSE-500 Index and 5 sectorial indices were launched in 1999
In 2001 BSE launched BSE-PSU Index DOLLEX-30 and the countrys first free-
float based index - the BSE TEC Index Over the years BSE shifted all its indices to
the free-float methodology
BSE disseminates information on the Price-Earnings Ratio the Price to Book Value
Ratio and the Dividend Yield Percentage on day-to-day basis of all its major indices
The values of all BSE indices are updated on real time basis during market hours and
displayed through the BOLT system BSE website and news wire agencies
All BSE Indices are reviewed periodically by the BSE Index Committee This
Committee which comprises eminent independent finance professionals frames the
broad policy guidelines for the development and maintenance of all BSE indices The
BSE Index Cell carries out the day-to-day maintenance of all indices and conducts
research on development of new indices
53
2951 BSE-100 Index
A broad-based index the BSE-100 was formerly known as the BSE National index
This Index has 1983-84 as the base year and was launched in 1989 In line with the
shift of the BSE Indices to the globally accepted Free-Float methodology BSE-100
was shifted to Free-Float methodology effective from April 5 2004 The method of
computation of Free-Float index and determination of free-float factors is similar to
the methodology for SENSEX
Table 25 Index Specification
Base Year 1983-84
Base Index Value 100
Date of Launch 3-Jan-89
Method of calculation Launched on full market capitalization
method and effective April 05 2004
calculation method shifted to free-float
market capitalization
Number of scrips 100
Index calculation frequency Real Time
Source wwwbseindiacom
2952 Base Year
The financial year 1983-84 has been chosen as the base year The price stability
during that year and proximity to the index series were the main consideration for
choice of 1983-84 as the base year The base value was fixed at 100 points
2953 Dollex-100
BSE also calculates a dollar-linked version of SENSEX and historical values of this
index are available since its inception
2954 BSE-100 index - Scrip Selection Criteria
The general guidelines for selection of constituents in BSE-100 are as follows
Trading Frequency The scrip should have been traded on 95 of the trading days
54
in the last three months Exceptions can be made for extreme reasons like scrip
suspension etc
Final Rank The scrip should figure in the top 200 companies listed by final rank
The final rank is arrived at by assigning 75 weighted to the rank on the basis of
three-month average full market capitalization and 25 weighted to the liquidity rank
based on three-month average daily turnover amp three-month average impact cost
IndustrySector Representation Scrip selection would generally take into account a
balanced sectorial representation of the listed companies in the universe of BSE
Track Record In the opinion of the BSE Index Committee the company should
have an acceptable track record
210 STOCK MARKET VOLATILITY
2101 Meaning
Volatility is a measure for variation of price of a financial instrument over time
Historic volatility is derived from time series of past market prices An implied
volatility is derived from the market price of a market traded derivative (in particular
an option) Volatility does not measure the direction of price changes merely their
dispersion This is because when calculating standard deviation (or variance) all
differences are squared so that negative and positive differences are combined into
one quantity Two instruments with different volatilities may have the same expected
return but the instrument with higher volatility will have larger swings in values over
a given period of time
For example a lower volatility stock may have an expected (average) return of 7
with annual volatility of 5 This would indicate returns from approximately negative
3 to positive 17 most of the time (19 times out of 20 or 95 via a two standard
deviation rule) A higher volatility stock with the same expected return of 7 but
with annual volatility of 20 would indicate returns from approximately negative
33 to positive 47 most of the time (19 times out of 20 or 95) These estimates
assume a normal distribution in reality stocks are found to be leptokurtotic
55
2102 Terminology used in volatility
Volatility as described here refers to the actual current volatility of a financial
instrument for a specified period (for example 30 days or 90 days) It is the volatility
of a financial instrument based on historical prices over the specified period with the
last observation the most recent price This phrase is used particularly when it is
wished to distinguish between the actual current volatility of an instrument and
actual historical volatility which refers to the volatility of a financial instrument
over a specified period but with the last observation on a date in the past
actual future volatility which refers to the volatility of a financial instrument
over a specified period starting at the current time and ending at a future date
(normally the expiry date of an options)
historical implied volatility which refers to the implied volatility observed from
historical prices of the financial instrument (normally options)
current implied volatility which refers to the implied volatility observed from
current prices of the financial instrument
future implied volatility which refers to the implied volatility observed from
future prices of the financial instrument
For a financial instrument whose price follows a random walk or wiener process the
width of the distribution increases as time increases This is because there is an
increasing profitability that the instruments price will be farther away from the initial
price as time increases However rather than increase linearly the volatility increases
with the square-root of time as time increases because some fluctuations are expected
to cancel each other out so the most likely deviation after twice the time will not be
twice the distance from zero
2103 Usefulness of volatility for Investors
Investors care about volatility for five reasons
1 The wider the swings in an investments price the harder emotionally it is to
not worry
2 Price volatility of a trading instrument can define position sizing in a portfolio
56
3 When certain cash flows from selling a security are needed at a specific future
date higher volatility means a greater chance of a shortfall
4 Higher volatility of returns while saving for retirement results in a wider
distribution of possible final portfolio values
5 Higher volatility of return when retired gives withdrawals a larger permanent
impact on the portfolios value
6 Price volatility presents opportunities to buy assets cheaply and sell when
overpriced
49
29332 Modified Capitalization Weighted
This method seeks to limit the influence of the largest stocks in the index which
otherwise would dominate the entire index This method sets a limit on the largest
stock or a group of stocks The NASDAQ 100 Index is calculated by using this
method
294 Free Float Market Capitalization Method
2941 Concept
Free float methodology refers to an index construction methodology that takes in to
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 Strategic holding government 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
All BSE indices with exception of BSE-PSU index have adopted the free-float
methodology
2942 Definition of Free Float
Share holding of investor that would not in the normal course come into the
open market for trading are treated as ―Controlling Strategic Holding and
hence not included in free float specifically the following categories of
holding are generally excluded from the definition of free float
Shares hold by foundersdirectorsacquires which has control element
Shares held by person with ―Controlling Interestlsquo
Shares held by Govt as promoters
50
Holding through the FDI Route
Strategic Stakes by private corporate bodiesindividuals
Equity held by employee welfare trusts
Locked-in-shares and shares which not be sold in the open market in normal
course
2943 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-agrave-Vis an investible
index This enables an apple-to-apple comparison thereby facilitating better
evaluation of performance of active managers
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 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
The free float methodology of index construction is considered to be an industry best
practice and all major index providers like MSCI FTSE SampP 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
51
29441 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 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 055 means that only 55 of the market
capitalization of the company will be considered for index calculation
Table 24 Free-float Bands
Free-Float Free-Float Factor Free-Float Free-Float Factor
gt0 - 5 005 gt50 - 55 055
gt5 - 10 010 gt55 - 60 060
gt10 - 15 015 gt60 - 65 065
gt15 - 20 020 gt65 - 70 070
gt20 - 25 025 gt70 - 75 075
gt25 - 30 030 gt75 - 80 080
gt30 - 35 035 gt80 - 85 085
gt35 - 40 040 gt85 - 90 090
gt40 - 45 045 gt90 - 95 095
gt45 - 50 050 gt95 - 100 100
Source wwwbseindiacom
295 BSE Indices
For the premier stock exchange that pioneered the securities transaction business
in India over a century of experience is a proud achievement A lot has changed since
1875 when 318 persons by paying a then princely amount of Re 1 became members
of what today is called Bombay Stock Exchange Limited (BSE) Over the decades
the stock market in the country has passed through good and bad periods The journey
52
in the 20th century has not been an easy one Till the decade of eighties there was no
measure or scale that could precisely measure the various ups and downs in the Indian
stock market BSE in 1986 came out with a Stock Index-SENSEX- that subsequently
became the barometer of the Indian stock market
The launch of SENSEX in 1986 was later followed up in January 1989 by
introduction of BSE National Index (Base 1983-84 = 100) It comprised 100 stocks
listed at five major stock exchanges in India - Mumbai Calcutta Delhi Ahmadabad
and Madras The BSE National Index was renamed BSE-100 Index from October 14
1996 and since then it is being calculated taking into consideration only the prices of
stocks listed at BSE BSE launched the dollar-linked version of BSE-100 index on
May 22 2006
With a view to provide a better representation of the increasing number of listed
companies larger market capitalization and the new industry sectors BSE launched
on 27th May 1994 two new index series viz the BSE-200 and the DOLLEX-200
Since then BSE has come a long way in attuning itself to the varied needs of
investors and market participants In order to fulfill the need for still broader
segment-specific and sector-specific indices BSE has continuously been increasing
the range of its indices BSE-500 Index and 5 sectorial indices were launched in 1999
In 2001 BSE launched BSE-PSU Index DOLLEX-30 and the countrys first free-
float based index - the BSE TEC Index Over the years BSE shifted all its indices to
the free-float methodology
BSE disseminates information on the Price-Earnings Ratio the Price to Book Value
Ratio and the Dividend Yield Percentage on day-to-day basis of all its major indices
The values of all BSE indices are updated on real time basis during market hours and
displayed through the BOLT system BSE website and news wire agencies
All BSE Indices are reviewed periodically by the BSE Index Committee This
Committee which comprises eminent independent finance professionals frames the
broad policy guidelines for the development and maintenance of all BSE indices The
BSE Index Cell carries out the day-to-day maintenance of all indices and conducts
research on development of new indices
53
2951 BSE-100 Index
A broad-based index the BSE-100 was formerly known as the BSE National index
This Index has 1983-84 as the base year and was launched in 1989 In line with the
shift of the BSE Indices to the globally accepted Free-Float methodology BSE-100
was shifted to Free-Float methodology effective from April 5 2004 The method of
computation of Free-Float index and determination of free-float factors is similar to
the methodology for SENSEX
Table 25 Index Specification
Base Year 1983-84
Base Index Value 100
Date of Launch 3-Jan-89
Method of calculation Launched on full market capitalization
method and effective April 05 2004
calculation method shifted to free-float
market capitalization
Number of scrips 100
Index calculation frequency Real Time
Source wwwbseindiacom
2952 Base Year
The financial year 1983-84 has been chosen as the base year The price stability
during that year and proximity to the index series were the main consideration for
choice of 1983-84 as the base year The base value was fixed at 100 points
2953 Dollex-100
BSE also calculates a dollar-linked version of SENSEX and historical values of this
index are available since its inception
2954 BSE-100 index - Scrip Selection Criteria
The general guidelines for selection of constituents in BSE-100 are as follows
Trading Frequency The scrip should have been traded on 95 of the trading days
54
in the last three months Exceptions can be made for extreme reasons like scrip
suspension etc
Final Rank The scrip should figure in the top 200 companies listed by final rank
The final rank is arrived at by assigning 75 weighted to the rank on the basis of
three-month average full market capitalization and 25 weighted to the liquidity rank
based on three-month average daily turnover amp three-month average impact cost
IndustrySector Representation Scrip selection would generally take into account a
balanced sectorial representation of the listed companies in the universe of BSE
Track Record In the opinion of the BSE Index Committee the company should
have an acceptable track record
210 STOCK MARKET VOLATILITY
2101 Meaning
Volatility is a measure for variation of price of a financial instrument over time
Historic volatility is derived from time series of past market prices An implied
volatility is derived from the market price of a market traded derivative (in particular
an option) Volatility does not measure the direction of price changes merely their
dispersion This is because when calculating standard deviation (or variance) all
differences are squared so that negative and positive differences are combined into
one quantity Two instruments with different volatilities may have the same expected
return but the instrument with higher volatility will have larger swings in values over
a given period of time
For example a lower volatility stock may have an expected (average) return of 7
with annual volatility of 5 This would indicate returns from approximately negative
3 to positive 17 most of the time (19 times out of 20 or 95 via a two standard
deviation rule) A higher volatility stock with the same expected return of 7 but
with annual volatility of 20 would indicate returns from approximately negative
33 to positive 47 most of the time (19 times out of 20 or 95) These estimates
assume a normal distribution in reality stocks are found to be leptokurtotic
55
2102 Terminology used in volatility
Volatility as described here refers to the actual current volatility of a financial
instrument for a specified period (for example 30 days or 90 days) It is the volatility
of a financial instrument based on historical prices over the specified period with the
last observation the most recent price This phrase is used particularly when it is
wished to distinguish between the actual current volatility of an instrument and
actual historical volatility which refers to the volatility of a financial instrument
over a specified period but with the last observation on a date in the past
actual future volatility which refers to the volatility of a financial instrument
over a specified period starting at the current time and ending at a future date
(normally the expiry date of an options)
historical implied volatility which refers to the implied volatility observed from
historical prices of the financial instrument (normally options)
current implied volatility which refers to the implied volatility observed from
current prices of the financial instrument
future implied volatility which refers to the implied volatility observed from
future prices of the financial instrument
For a financial instrument whose price follows a random walk or wiener process the
width of the distribution increases as time increases This is because there is an
increasing profitability that the instruments price will be farther away from the initial
price as time increases However rather than increase linearly the volatility increases
with the square-root of time as time increases because some fluctuations are expected
to cancel each other out so the most likely deviation after twice the time will not be
twice the distance from zero
2103 Usefulness of volatility for Investors
Investors care about volatility for five reasons
1 The wider the swings in an investments price the harder emotionally it is to
not worry
2 Price volatility of a trading instrument can define position sizing in a portfolio
56
3 When certain cash flows from selling a security are needed at a specific future
date higher volatility means a greater chance of a shortfall
4 Higher volatility of returns while saving for retirement results in a wider
distribution of possible final portfolio values
5 Higher volatility of return when retired gives withdrawals a larger permanent
impact on the portfolios value
6 Price volatility presents opportunities to buy assets cheaply and sell when
overpriced
50
Holding through the FDI Route
Strategic Stakes by private corporate bodiesindividuals
Equity held by employee welfare trusts
Locked-in-shares and shares which not be sold in the open market in normal
course
2943 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-agrave-Vis an investible
index This enables an apple-to-apple comparison thereby facilitating better
evaluation of performance of active managers
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 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
The free float methodology of index construction is considered to be an industry best
practice and all major index providers like MSCI FTSE SampP 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
51
29441 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 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 055 means that only 55 of the market
capitalization of the company will be considered for index calculation
Table 24 Free-float Bands
Free-Float Free-Float Factor Free-Float Free-Float Factor
gt0 - 5 005 gt50 - 55 055
gt5 - 10 010 gt55 - 60 060
gt10 - 15 015 gt60 - 65 065
gt15 - 20 020 gt65 - 70 070
gt20 - 25 025 gt70 - 75 075
gt25 - 30 030 gt75 - 80 080
gt30 - 35 035 gt80 - 85 085
gt35 - 40 040 gt85 - 90 090
gt40 - 45 045 gt90 - 95 095
gt45 - 50 050 gt95 - 100 100
Source wwwbseindiacom
295 BSE Indices
For the premier stock exchange that pioneered the securities transaction business
in India over a century of experience is a proud achievement A lot has changed since
1875 when 318 persons by paying a then princely amount of Re 1 became members
of what today is called Bombay Stock Exchange Limited (BSE) Over the decades
the stock market in the country has passed through good and bad periods The journey
52
in the 20th century has not been an easy one Till the decade of eighties there was no
measure or scale that could precisely measure the various ups and downs in the Indian
stock market BSE in 1986 came out with a Stock Index-SENSEX- that subsequently
became the barometer of the Indian stock market
The launch of SENSEX in 1986 was later followed up in January 1989 by
introduction of BSE National Index (Base 1983-84 = 100) It comprised 100 stocks
listed at five major stock exchanges in India - Mumbai Calcutta Delhi Ahmadabad
and Madras The BSE National Index was renamed BSE-100 Index from October 14
1996 and since then it is being calculated taking into consideration only the prices of
stocks listed at BSE BSE launched the dollar-linked version of BSE-100 index on
May 22 2006
With a view to provide a better representation of the increasing number of listed
companies larger market capitalization and the new industry sectors BSE launched
on 27th May 1994 two new index series viz the BSE-200 and the DOLLEX-200
Since then BSE has come a long way in attuning itself to the varied needs of
investors and market participants In order to fulfill the need for still broader
segment-specific and sector-specific indices BSE has continuously been increasing
the range of its indices BSE-500 Index and 5 sectorial indices were launched in 1999
In 2001 BSE launched BSE-PSU Index DOLLEX-30 and the countrys first free-
float based index - the BSE TEC Index Over the years BSE shifted all its indices to
the free-float methodology
BSE disseminates information on the Price-Earnings Ratio the Price to Book Value
Ratio and the Dividend Yield Percentage on day-to-day basis of all its major indices
The values of all BSE indices are updated on real time basis during market hours and
displayed through the BOLT system BSE website and news wire agencies
All BSE Indices are reviewed periodically by the BSE Index Committee This
Committee which comprises eminent independent finance professionals frames the
broad policy guidelines for the development and maintenance of all BSE indices The
BSE Index Cell carries out the day-to-day maintenance of all indices and conducts
research on development of new indices
53
2951 BSE-100 Index
A broad-based index the BSE-100 was formerly known as the BSE National index
This Index has 1983-84 as the base year and was launched in 1989 In line with the
shift of the BSE Indices to the globally accepted Free-Float methodology BSE-100
was shifted to Free-Float methodology effective from April 5 2004 The method of
computation of Free-Float index and determination of free-float factors is similar to
the methodology for SENSEX
Table 25 Index Specification
Base Year 1983-84
Base Index Value 100
Date of Launch 3-Jan-89
Method of calculation Launched on full market capitalization
method and effective April 05 2004
calculation method shifted to free-float
market capitalization
Number of scrips 100
Index calculation frequency Real Time
Source wwwbseindiacom
2952 Base Year
The financial year 1983-84 has been chosen as the base year The price stability
during that year and proximity to the index series were the main consideration for
choice of 1983-84 as the base year The base value was fixed at 100 points
2953 Dollex-100
BSE also calculates a dollar-linked version of SENSEX and historical values of this
index are available since its inception
2954 BSE-100 index - Scrip Selection Criteria
The general guidelines for selection of constituents in BSE-100 are as follows
Trading Frequency The scrip should have been traded on 95 of the trading days
54
in the last three months Exceptions can be made for extreme reasons like scrip
suspension etc
Final Rank The scrip should figure in the top 200 companies listed by final rank
The final rank is arrived at by assigning 75 weighted to the rank on the basis of
three-month average full market capitalization and 25 weighted to the liquidity rank
based on three-month average daily turnover amp three-month average impact cost
IndustrySector Representation Scrip selection would generally take into account a
balanced sectorial representation of the listed companies in the universe of BSE
Track Record In the opinion of the BSE Index Committee the company should
have an acceptable track record
210 STOCK MARKET VOLATILITY
2101 Meaning
Volatility is a measure for variation of price of a financial instrument over time
Historic volatility is derived from time series of past market prices An implied
volatility is derived from the market price of a market traded derivative (in particular
an option) Volatility does not measure the direction of price changes merely their
dispersion This is because when calculating standard deviation (or variance) all
differences are squared so that negative and positive differences are combined into
one quantity Two instruments with different volatilities may have the same expected
return but the instrument with higher volatility will have larger swings in values over
a given period of time
For example a lower volatility stock may have an expected (average) return of 7
with annual volatility of 5 This would indicate returns from approximately negative
3 to positive 17 most of the time (19 times out of 20 or 95 via a two standard
deviation rule) A higher volatility stock with the same expected return of 7 but
with annual volatility of 20 would indicate returns from approximately negative
33 to positive 47 most of the time (19 times out of 20 or 95) These estimates
assume a normal distribution in reality stocks are found to be leptokurtotic
55
2102 Terminology used in volatility
Volatility as described here refers to the actual current volatility of a financial
instrument for a specified period (for example 30 days or 90 days) It is the volatility
of a financial instrument based on historical prices over the specified period with the
last observation the most recent price This phrase is used particularly when it is
wished to distinguish between the actual current volatility of an instrument and
actual historical volatility which refers to the volatility of a financial instrument
over a specified period but with the last observation on a date in the past
actual future volatility which refers to the volatility of a financial instrument
over a specified period starting at the current time and ending at a future date
(normally the expiry date of an options)
historical implied volatility which refers to the implied volatility observed from
historical prices of the financial instrument (normally options)
current implied volatility which refers to the implied volatility observed from
current prices of the financial instrument
future implied volatility which refers to the implied volatility observed from
future prices of the financial instrument
For a financial instrument whose price follows a random walk or wiener process the
width of the distribution increases as time increases This is because there is an
increasing profitability that the instruments price will be farther away from the initial
price as time increases However rather than increase linearly the volatility increases
with the square-root of time as time increases because some fluctuations are expected
to cancel each other out so the most likely deviation after twice the time will not be
twice the distance from zero
2103 Usefulness of volatility for Investors
Investors care about volatility for five reasons
1 The wider the swings in an investments price the harder emotionally it is to
not worry
2 Price volatility of a trading instrument can define position sizing in a portfolio
56
3 When certain cash flows from selling a security are needed at a specific future
date higher volatility means a greater chance of a shortfall
4 Higher volatility of returns while saving for retirement results in a wider
distribution of possible final portfolio values
5 Higher volatility of return when retired gives withdrawals a larger permanent
impact on the portfolios value
6 Price volatility presents opportunities to buy assets cheaply and sell when
overpriced
51
29441 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 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 055 means that only 55 of the market
capitalization of the company will be considered for index calculation
Table 24 Free-float Bands
Free-Float Free-Float Factor Free-Float Free-Float Factor
gt0 - 5 005 gt50 - 55 055
gt5 - 10 010 gt55 - 60 060
gt10 - 15 015 gt60 - 65 065
gt15 - 20 020 gt65 - 70 070
gt20 - 25 025 gt70 - 75 075
gt25 - 30 030 gt75 - 80 080
gt30 - 35 035 gt80 - 85 085
gt35 - 40 040 gt85 - 90 090
gt40 - 45 045 gt90 - 95 095
gt45 - 50 050 gt95 - 100 100
Source wwwbseindiacom
295 BSE Indices
For the premier stock exchange that pioneered the securities transaction business
in India over a century of experience is a proud achievement A lot has changed since
1875 when 318 persons by paying a then princely amount of Re 1 became members
of what today is called Bombay Stock Exchange Limited (BSE) Over the decades
the stock market in the country has passed through good and bad periods The journey
52
in the 20th century has not been an easy one Till the decade of eighties there was no
measure or scale that could precisely measure the various ups and downs in the Indian
stock market BSE in 1986 came out with a Stock Index-SENSEX- that subsequently
became the barometer of the Indian stock market
The launch of SENSEX in 1986 was later followed up in January 1989 by
introduction of BSE National Index (Base 1983-84 = 100) It comprised 100 stocks
listed at five major stock exchanges in India - Mumbai Calcutta Delhi Ahmadabad
and Madras The BSE National Index was renamed BSE-100 Index from October 14
1996 and since then it is being calculated taking into consideration only the prices of
stocks listed at BSE BSE launched the dollar-linked version of BSE-100 index on
May 22 2006
With a view to provide a better representation of the increasing number of listed
companies larger market capitalization and the new industry sectors BSE launched
on 27th May 1994 two new index series viz the BSE-200 and the DOLLEX-200
Since then BSE has come a long way in attuning itself to the varied needs of
investors and market participants In order to fulfill the need for still broader
segment-specific and sector-specific indices BSE has continuously been increasing
the range of its indices BSE-500 Index and 5 sectorial indices were launched in 1999
In 2001 BSE launched BSE-PSU Index DOLLEX-30 and the countrys first free-
float based index - the BSE TEC Index Over the years BSE shifted all its indices to
the free-float methodology
BSE disseminates information on the Price-Earnings Ratio the Price to Book Value
Ratio and the Dividend Yield Percentage on day-to-day basis of all its major indices
The values of all BSE indices are updated on real time basis during market hours and
displayed through the BOLT system BSE website and news wire agencies
All BSE Indices are reviewed periodically by the BSE Index Committee This
Committee which comprises eminent independent finance professionals frames the
broad policy guidelines for the development and maintenance of all BSE indices The
BSE Index Cell carries out the day-to-day maintenance of all indices and conducts
research on development of new indices
53
2951 BSE-100 Index
A broad-based index the BSE-100 was formerly known as the BSE National index
This Index has 1983-84 as the base year and was launched in 1989 In line with the
shift of the BSE Indices to the globally accepted Free-Float methodology BSE-100
was shifted to Free-Float methodology effective from April 5 2004 The method of
computation of Free-Float index and determination of free-float factors is similar to
the methodology for SENSEX
Table 25 Index Specification
Base Year 1983-84
Base Index Value 100
Date of Launch 3-Jan-89
Method of calculation Launched on full market capitalization
method and effective April 05 2004
calculation method shifted to free-float
market capitalization
Number of scrips 100
Index calculation frequency Real Time
Source wwwbseindiacom
2952 Base Year
The financial year 1983-84 has been chosen as the base year The price stability
during that year and proximity to the index series were the main consideration for
choice of 1983-84 as the base year The base value was fixed at 100 points
2953 Dollex-100
BSE also calculates a dollar-linked version of SENSEX and historical values of this
index are available since its inception
2954 BSE-100 index - Scrip Selection Criteria
The general guidelines for selection of constituents in BSE-100 are as follows
Trading Frequency The scrip should have been traded on 95 of the trading days
54
in the last three months Exceptions can be made for extreme reasons like scrip
suspension etc
Final Rank The scrip should figure in the top 200 companies listed by final rank
The final rank is arrived at by assigning 75 weighted to the rank on the basis of
three-month average full market capitalization and 25 weighted to the liquidity rank
based on three-month average daily turnover amp three-month average impact cost
IndustrySector Representation Scrip selection would generally take into account a
balanced sectorial representation of the listed companies in the universe of BSE
Track Record In the opinion of the BSE Index Committee the company should
have an acceptable track record
210 STOCK MARKET VOLATILITY
2101 Meaning
Volatility is a measure for variation of price of a financial instrument over time
Historic volatility is derived from time series of past market prices An implied
volatility is derived from the market price of a market traded derivative (in particular
an option) Volatility does not measure the direction of price changes merely their
dispersion This is because when calculating standard deviation (or variance) all
differences are squared so that negative and positive differences are combined into
one quantity Two instruments with different volatilities may have the same expected
return but the instrument with higher volatility will have larger swings in values over
a given period of time
For example a lower volatility stock may have an expected (average) return of 7
with annual volatility of 5 This would indicate returns from approximately negative
3 to positive 17 most of the time (19 times out of 20 or 95 via a two standard
deviation rule) A higher volatility stock with the same expected return of 7 but
with annual volatility of 20 would indicate returns from approximately negative
33 to positive 47 most of the time (19 times out of 20 or 95) These estimates
assume a normal distribution in reality stocks are found to be leptokurtotic
55
2102 Terminology used in volatility
Volatility as described here refers to the actual current volatility of a financial
instrument for a specified period (for example 30 days or 90 days) It is the volatility
of a financial instrument based on historical prices over the specified period with the
last observation the most recent price This phrase is used particularly when it is
wished to distinguish between the actual current volatility of an instrument and
actual historical volatility which refers to the volatility of a financial instrument
over a specified period but with the last observation on a date in the past
actual future volatility which refers to the volatility of a financial instrument
over a specified period starting at the current time and ending at a future date
(normally the expiry date of an options)
historical implied volatility which refers to the implied volatility observed from
historical prices of the financial instrument (normally options)
current implied volatility which refers to the implied volatility observed from
current prices of the financial instrument
future implied volatility which refers to the implied volatility observed from
future prices of the financial instrument
For a financial instrument whose price follows a random walk or wiener process the
width of the distribution increases as time increases This is because there is an
increasing profitability that the instruments price will be farther away from the initial
price as time increases However rather than increase linearly the volatility increases
with the square-root of time as time increases because some fluctuations are expected
to cancel each other out so the most likely deviation after twice the time will not be
twice the distance from zero
2103 Usefulness of volatility for Investors
Investors care about volatility for five reasons
1 The wider the swings in an investments price the harder emotionally it is to
not worry
2 Price volatility of a trading instrument can define position sizing in a portfolio
56
3 When certain cash flows from selling a security are needed at a specific future
date higher volatility means a greater chance of a shortfall
4 Higher volatility of returns while saving for retirement results in a wider
distribution of possible final portfolio values
5 Higher volatility of return when retired gives withdrawals a larger permanent
impact on the portfolios value
6 Price volatility presents opportunities to buy assets cheaply and sell when
overpriced
52
in the 20th century has not been an easy one Till the decade of eighties there was no
measure or scale that could precisely measure the various ups and downs in the Indian
stock market BSE in 1986 came out with a Stock Index-SENSEX- that subsequently
became the barometer of the Indian stock market
The launch of SENSEX in 1986 was later followed up in January 1989 by
introduction of BSE National Index (Base 1983-84 = 100) It comprised 100 stocks
listed at five major stock exchanges in India - Mumbai Calcutta Delhi Ahmadabad
and Madras The BSE National Index was renamed BSE-100 Index from October 14
1996 and since then it is being calculated taking into consideration only the prices of
stocks listed at BSE BSE launched the dollar-linked version of BSE-100 index on
May 22 2006
With a view to provide a better representation of the increasing number of listed
companies larger market capitalization and the new industry sectors BSE launched
on 27th May 1994 two new index series viz the BSE-200 and the DOLLEX-200
Since then BSE has come a long way in attuning itself to the varied needs of
investors and market participants In order to fulfill the need for still broader
segment-specific and sector-specific indices BSE has continuously been increasing
the range of its indices BSE-500 Index and 5 sectorial indices were launched in 1999
In 2001 BSE launched BSE-PSU Index DOLLEX-30 and the countrys first free-
float based index - the BSE TEC Index Over the years BSE shifted all its indices to
the free-float methodology
BSE disseminates information on the Price-Earnings Ratio the Price to Book Value
Ratio and the Dividend Yield Percentage on day-to-day basis of all its major indices
The values of all BSE indices are updated on real time basis during market hours and
displayed through the BOLT system BSE website and news wire agencies
All BSE Indices are reviewed periodically by the BSE Index Committee This
Committee which comprises eminent independent finance professionals frames the
broad policy guidelines for the development and maintenance of all BSE indices The
BSE Index Cell carries out the day-to-day maintenance of all indices and conducts
research on development of new indices
53
2951 BSE-100 Index
A broad-based index the BSE-100 was formerly known as the BSE National index
This Index has 1983-84 as the base year and was launched in 1989 In line with the
shift of the BSE Indices to the globally accepted Free-Float methodology BSE-100
was shifted to Free-Float methodology effective from April 5 2004 The method of
computation of Free-Float index and determination of free-float factors is similar to
the methodology for SENSEX
Table 25 Index Specification
Base Year 1983-84
Base Index Value 100
Date of Launch 3-Jan-89
Method of calculation Launched on full market capitalization
method and effective April 05 2004
calculation method shifted to free-float
market capitalization
Number of scrips 100
Index calculation frequency Real Time
Source wwwbseindiacom
2952 Base Year
The financial year 1983-84 has been chosen as the base year The price stability
during that year and proximity to the index series were the main consideration for
choice of 1983-84 as the base year The base value was fixed at 100 points
2953 Dollex-100
BSE also calculates a dollar-linked version of SENSEX and historical values of this
index are available since its inception
2954 BSE-100 index - Scrip Selection Criteria
The general guidelines for selection of constituents in BSE-100 are as follows
Trading Frequency The scrip should have been traded on 95 of the trading days
54
in the last three months Exceptions can be made for extreme reasons like scrip
suspension etc
Final Rank The scrip should figure in the top 200 companies listed by final rank
The final rank is arrived at by assigning 75 weighted to the rank on the basis of
three-month average full market capitalization and 25 weighted to the liquidity rank
based on three-month average daily turnover amp three-month average impact cost
IndustrySector Representation Scrip selection would generally take into account a
balanced sectorial representation of the listed companies in the universe of BSE
Track Record In the opinion of the BSE Index Committee the company should
have an acceptable track record
210 STOCK MARKET VOLATILITY
2101 Meaning
Volatility is a measure for variation of price of a financial instrument over time
Historic volatility is derived from time series of past market prices An implied
volatility is derived from the market price of a market traded derivative (in particular
an option) Volatility does not measure the direction of price changes merely their
dispersion This is because when calculating standard deviation (or variance) all
differences are squared so that negative and positive differences are combined into
one quantity Two instruments with different volatilities may have the same expected
return but the instrument with higher volatility will have larger swings in values over
a given period of time
For example a lower volatility stock may have an expected (average) return of 7
with annual volatility of 5 This would indicate returns from approximately negative
3 to positive 17 most of the time (19 times out of 20 or 95 via a two standard
deviation rule) A higher volatility stock with the same expected return of 7 but
with annual volatility of 20 would indicate returns from approximately negative
33 to positive 47 most of the time (19 times out of 20 or 95) These estimates
assume a normal distribution in reality stocks are found to be leptokurtotic
55
2102 Terminology used in volatility
Volatility as described here refers to the actual current volatility of a financial
instrument for a specified period (for example 30 days or 90 days) It is the volatility
of a financial instrument based on historical prices over the specified period with the
last observation the most recent price This phrase is used particularly when it is
wished to distinguish between the actual current volatility of an instrument and
actual historical volatility which refers to the volatility of a financial instrument
over a specified period but with the last observation on a date in the past
actual future volatility which refers to the volatility of a financial instrument
over a specified period starting at the current time and ending at a future date
(normally the expiry date of an options)
historical implied volatility which refers to the implied volatility observed from
historical prices of the financial instrument (normally options)
current implied volatility which refers to the implied volatility observed from
current prices of the financial instrument
future implied volatility which refers to the implied volatility observed from
future prices of the financial instrument
For a financial instrument whose price follows a random walk or wiener process the
width of the distribution increases as time increases This is because there is an
increasing profitability that the instruments price will be farther away from the initial
price as time increases However rather than increase linearly the volatility increases
with the square-root of time as time increases because some fluctuations are expected
to cancel each other out so the most likely deviation after twice the time will not be
twice the distance from zero
2103 Usefulness of volatility for Investors
Investors care about volatility for five reasons
1 The wider the swings in an investments price the harder emotionally it is to
not worry
2 Price volatility of a trading instrument can define position sizing in a portfolio
56
3 When certain cash flows from selling a security are needed at a specific future
date higher volatility means a greater chance of a shortfall
4 Higher volatility of returns while saving for retirement results in a wider
distribution of possible final portfolio values
5 Higher volatility of return when retired gives withdrawals a larger permanent
impact on the portfolios value
6 Price volatility presents opportunities to buy assets cheaply and sell when
overpriced
53
2951 BSE-100 Index
A broad-based index the BSE-100 was formerly known as the BSE National index
This Index has 1983-84 as the base year and was launched in 1989 In line with the
shift of the BSE Indices to the globally accepted Free-Float methodology BSE-100
was shifted to Free-Float methodology effective from April 5 2004 The method of
computation of Free-Float index and determination of free-float factors is similar to
the methodology for SENSEX
Table 25 Index Specification
Base Year 1983-84
Base Index Value 100
Date of Launch 3-Jan-89
Method of calculation Launched on full market capitalization
method and effective April 05 2004
calculation method shifted to free-float
market capitalization
Number of scrips 100
Index calculation frequency Real Time
Source wwwbseindiacom
2952 Base Year
The financial year 1983-84 has been chosen as the base year The price stability
during that year and proximity to the index series were the main consideration for
choice of 1983-84 as the base year The base value was fixed at 100 points
2953 Dollex-100
BSE also calculates a dollar-linked version of SENSEX and historical values of this
index are available since its inception
2954 BSE-100 index - Scrip Selection Criteria
The general guidelines for selection of constituents in BSE-100 are as follows
Trading Frequency The scrip should have been traded on 95 of the trading days
54
in the last three months Exceptions can be made for extreme reasons like scrip
suspension etc
Final Rank The scrip should figure in the top 200 companies listed by final rank
The final rank is arrived at by assigning 75 weighted to the rank on the basis of
three-month average full market capitalization and 25 weighted to the liquidity rank
based on three-month average daily turnover amp three-month average impact cost
IndustrySector Representation Scrip selection would generally take into account a
balanced sectorial representation of the listed companies in the universe of BSE
Track Record In the opinion of the BSE Index Committee the company should
have an acceptable track record
210 STOCK MARKET VOLATILITY
2101 Meaning
Volatility is a measure for variation of price of a financial instrument over time
Historic volatility is derived from time series of past market prices An implied
volatility is derived from the market price of a market traded derivative (in particular
an option) Volatility does not measure the direction of price changes merely their
dispersion This is because when calculating standard deviation (or variance) all
differences are squared so that negative and positive differences are combined into
one quantity Two instruments with different volatilities may have the same expected
return but the instrument with higher volatility will have larger swings in values over
a given period of time
For example a lower volatility stock may have an expected (average) return of 7
with annual volatility of 5 This would indicate returns from approximately negative
3 to positive 17 most of the time (19 times out of 20 or 95 via a two standard
deviation rule) A higher volatility stock with the same expected return of 7 but
with annual volatility of 20 would indicate returns from approximately negative
33 to positive 47 most of the time (19 times out of 20 or 95) These estimates
assume a normal distribution in reality stocks are found to be leptokurtotic
55
2102 Terminology used in volatility
Volatility as described here refers to the actual current volatility of a financial
instrument for a specified period (for example 30 days or 90 days) It is the volatility
of a financial instrument based on historical prices over the specified period with the
last observation the most recent price This phrase is used particularly when it is
wished to distinguish between the actual current volatility of an instrument and
actual historical volatility which refers to the volatility of a financial instrument
over a specified period but with the last observation on a date in the past
actual future volatility which refers to the volatility of a financial instrument
over a specified period starting at the current time and ending at a future date
(normally the expiry date of an options)
historical implied volatility which refers to the implied volatility observed from
historical prices of the financial instrument (normally options)
current implied volatility which refers to the implied volatility observed from
current prices of the financial instrument
future implied volatility which refers to the implied volatility observed from
future prices of the financial instrument
For a financial instrument whose price follows a random walk or wiener process the
width of the distribution increases as time increases This is because there is an
increasing profitability that the instruments price will be farther away from the initial
price as time increases However rather than increase linearly the volatility increases
with the square-root of time as time increases because some fluctuations are expected
to cancel each other out so the most likely deviation after twice the time will not be
twice the distance from zero
2103 Usefulness of volatility for Investors
Investors care about volatility for five reasons
1 The wider the swings in an investments price the harder emotionally it is to
not worry
2 Price volatility of a trading instrument can define position sizing in a portfolio
56
3 When certain cash flows from selling a security are needed at a specific future
date higher volatility means a greater chance of a shortfall
4 Higher volatility of returns while saving for retirement results in a wider
distribution of possible final portfolio values
5 Higher volatility of return when retired gives withdrawals a larger permanent
impact on the portfolios value
6 Price volatility presents opportunities to buy assets cheaply and sell when
overpriced
54
in the last three months Exceptions can be made for extreme reasons like scrip
suspension etc
Final Rank The scrip should figure in the top 200 companies listed by final rank
The final rank is arrived at by assigning 75 weighted to the rank on the basis of
three-month average full market capitalization and 25 weighted to the liquidity rank
based on three-month average daily turnover amp three-month average impact cost
IndustrySector Representation Scrip selection would generally take into account a
balanced sectorial representation of the listed companies in the universe of BSE
Track Record In the opinion of the BSE Index Committee the company should
have an acceptable track record
210 STOCK MARKET VOLATILITY
2101 Meaning
Volatility is a measure for variation of price of a financial instrument over time
Historic volatility is derived from time series of past market prices An implied
volatility is derived from the market price of a market traded derivative (in particular
an option) Volatility does not measure the direction of price changes merely their
dispersion This is because when calculating standard deviation (or variance) all
differences are squared so that negative and positive differences are combined into
one quantity Two instruments with different volatilities may have the same expected
return but the instrument with higher volatility will have larger swings in values over
a given period of time
For example a lower volatility stock may have an expected (average) return of 7
with annual volatility of 5 This would indicate returns from approximately negative
3 to positive 17 most of the time (19 times out of 20 or 95 via a two standard
deviation rule) A higher volatility stock with the same expected return of 7 but
with annual volatility of 20 would indicate returns from approximately negative
33 to positive 47 most of the time (19 times out of 20 or 95) These estimates
assume a normal distribution in reality stocks are found to be leptokurtotic
55
2102 Terminology used in volatility
Volatility as described here refers to the actual current volatility of a financial
instrument for a specified period (for example 30 days or 90 days) It is the volatility
of a financial instrument based on historical prices over the specified period with the
last observation the most recent price This phrase is used particularly when it is
wished to distinguish between the actual current volatility of an instrument and
actual historical volatility which refers to the volatility of a financial instrument
over a specified period but with the last observation on a date in the past
actual future volatility which refers to the volatility of a financial instrument
over a specified period starting at the current time and ending at a future date
(normally the expiry date of an options)
historical implied volatility which refers to the implied volatility observed from
historical prices of the financial instrument (normally options)
current implied volatility which refers to the implied volatility observed from
current prices of the financial instrument
future implied volatility which refers to the implied volatility observed from
future prices of the financial instrument
For a financial instrument whose price follows a random walk or wiener process the
width of the distribution increases as time increases This is because there is an
increasing profitability that the instruments price will be farther away from the initial
price as time increases However rather than increase linearly the volatility increases
with the square-root of time as time increases because some fluctuations are expected
to cancel each other out so the most likely deviation after twice the time will not be
twice the distance from zero
2103 Usefulness of volatility for Investors
Investors care about volatility for five reasons
1 The wider the swings in an investments price the harder emotionally it is to
not worry
2 Price volatility of a trading instrument can define position sizing in a portfolio
56
3 When certain cash flows from selling a security are needed at a specific future
date higher volatility means a greater chance of a shortfall
4 Higher volatility of returns while saving for retirement results in a wider
distribution of possible final portfolio values
5 Higher volatility of return when retired gives withdrawals a larger permanent
impact on the portfolios value
6 Price volatility presents opportunities to buy assets cheaply and sell when
overpriced
55
2102 Terminology used in volatility
Volatility as described here refers to the actual current volatility of a financial
instrument for a specified period (for example 30 days or 90 days) It is the volatility
of a financial instrument based on historical prices over the specified period with the
last observation the most recent price This phrase is used particularly when it is
wished to distinguish between the actual current volatility of an instrument and
actual historical volatility which refers to the volatility of a financial instrument
over a specified period but with the last observation on a date in the past
actual future volatility which refers to the volatility of a financial instrument
over a specified period starting at the current time and ending at a future date
(normally the expiry date of an options)
historical implied volatility which refers to the implied volatility observed from
historical prices of the financial instrument (normally options)
current implied volatility which refers to the implied volatility observed from
current prices of the financial instrument
future implied volatility which refers to the implied volatility observed from
future prices of the financial instrument
For a financial instrument whose price follows a random walk or wiener process the
width of the distribution increases as time increases This is because there is an
increasing profitability that the instruments price will be farther away from the initial
price as time increases However rather than increase linearly the volatility increases
with the square-root of time as time increases because some fluctuations are expected
to cancel each other out so the most likely deviation after twice the time will not be
twice the distance from zero
2103 Usefulness of volatility for Investors
Investors care about volatility for five reasons
1 The wider the swings in an investments price the harder emotionally it is to
not worry
2 Price volatility of a trading instrument can define position sizing in a portfolio
56
3 When certain cash flows from selling a security are needed at a specific future
date higher volatility means a greater chance of a shortfall
4 Higher volatility of returns while saving for retirement results in a wider
distribution of possible final portfolio values
5 Higher volatility of return when retired gives withdrawals a larger permanent
impact on the portfolios value
6 Price volatility presents opportunities to buy assets cheaply and sell when
overpriced
56
3 When certain cash flows from selling a security are needed at a specific future
date higher volatility means a greater chance of a shortfall
4 Higher volatility of returns while saving for retirement results in a wider
distribution of possible final portfolio values
5 Higher volatility of return when retired gives withdrawals a larger permanent
impact on the portfolios value
6 Price volatility presents opportunities to buy assets cheaply and sell when
overpriced