NISM Hyderabad : Index Constructon : AS Chakravarthy

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Index Construction Methods

A good Index is an exchange off amongst expansion and liquidity. A well diversified index is more representative of the market/economy.

The Stock Market Indices construction methodologies are
    (a) Free Float Market Capitalization Weighted Index,
    (b) Market Capitalization Weighted index and the
    (c) Price Weighted Index.

Free Float Market Capitalisation Weighted Index: The free float factor (Investible Weight Factor), for each company in the index is determined based on the public shareholding of the companies as disclosed in the shareholding pattern submitted to the stock exchange by these companies.

The Free float market capitalization is calculated as below:

Free Float Market Capitalisation = Issue Size * Price * Investible Weight Factor

The Index in this case is calculated as per the formulae given below:

The following Indices introduced the free float market capitalization methodology by The India Index Services Limited (IISL), a joint venture between the NSE and CRISIL,

S&P CNX Nifty,
S&P CNX Defty,
CNX Nifty Junior and
CNX 100.

Market Capitalisation Weighted Index: In this type of index calculation, each stock in the index affects the index value in proportion to the market value of all shares outstanding. In this the index would be calculated as per the formulae below:

Where,

Current market capitalization = Sum of (current market price * Issue size) of all securities in the index.
Base market capitalization = Sum of (market price * issue size) of all securities as on base date.

Similarly, in a price weighted index each stock influences the index in proportion to its price per share. The value of the index is generated by adding the prices of each of the stocks in the index and dividing then by the total number of stocks. Stocks with a higher price will be given more weight and, therefore, will have a greater influence over the performance of the index.

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