How is the BSE Sensex Calculated?

The Sensex has a very important function. The Sensex acts as an indicator of the stocks in the BSE. It is supposed to show whether the stocks are generally going up, or generally going down. To perform this accurately, the Sensex is calculated taking into consideration stock prices of 30 different BSE listed companies. It is calculated using the “free-float market capitalization” method, which is a world wide accepted method as one of the best methods for calculating a stock market index. It should be noted that the method used for calculating the Sensex and the 30 companies that are taken into consideration are changed from time to time. This is done to make the Sensex an accurate index and so that it represents the BSE stocks properly. To understand how the Sensex is calculated, you simply need to understand what the term “free-float market capitalization” means, but first a note on Market Capitalization Market Capitalization Market capitalization represents the public consensus on the value of a company’s equity. A corporation, including all of its assets, may be freely bought and sold through purchases and sales of stock, which determines the price of the company’s shares. Its market capitalization is this share price multiplied by the number of shares in issue, providing a total value for the company’s shares and thus for the company as a whole. Many companies have a dominant shareholder, which may be a government entity, a family, or another corporation. Many stockmarket indices (S&P 500, Sensex, FTSE, DAX, Nikkei, MSCI) adjust for these by calculating on a “free float” basis, ie the market capitalization they use is the value of the publicly tradable part of the company. Note that market capitalization is a market estimate of a company’s value, based on perceived future prospects, economic and monetary conditions, and therefore largely independent of a company’s history. Stock prices can also be moved by just speculation about changes in expectations about profits or about mergers and acquisitions. Now lets try to understand Free Float Market Capitalization. Free Float Market Capitalization Under the ‘full-market capitalization’ methodology, the total market capitalization of a company, irrespective of who is holding the shares, is taken into consideration for computation of an index. However, if instead of taking the total market capitalization, only the Free-float market capitalization of a company is considered for index calculation, it is called the Free-float methodology. Free-float market capitalization is defined as that proportion of total shares issued by the company, which are readily available for trading in the market. It generally does not include promoters’ holding, government holding, strategic holding and other locked-in shares, which will not come to the market for trading in the normal course. Thus, the market capitalization of each company in a Free-float index is reduced to the extent of its Free-float available in the market. Free Float Methodology Free Float Methodology is a method by which the market capitalization of an index’s underlying companies is calculated. Free-float methodology market capitalization is calculated by taking the equity’s price and multiplying it by the number of shares readily available in the market. Instead of using all of the shares outstanding like the full-market capitalization method, the free-float method excludes locked-in shares such as those held by promoters and governments. Calculated as: FFM = Share Price x (# Shares Oustanding – Locked In Shares) The free-float method is seen as a better way of calculating market capitalization because it provides a more accurate reflection of market movements. When using a free-float methodology, the resulting market capitalization is smaller than what would result from a full-market capitalization method. Free-float methodology has been adopted by most of the world’s major indexes, including the Dow Jones Industrial Average and the S&P 500

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