Sri Ramakrishna Engineering College (Autonomous Institution Affiliated to Anna University of Technology Coimbatore) Vattamalaipalayam , NGGO Colony Post

Coimbatore - 641022 Department of Management Studies Security Analysis and Portfolio Management
10DCF01

Term Paper
on
WHAT ARE THE CRITERIA APPLIED TO INCLUDE STOCKS IN BSE

Submitted by V.Uthra 1091057

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WHAT ARE THE CRITERIAS APPLIED TO INCLUDE STOCKS IN BSE The Bombay Stock Exchange (BSE) (formerly, The Stock Exchange, Bombay) is a stock exchange located on Dalal Street, Mumbai and is the oldest stock exchange in Asia. The equity market capitalization of the companies listed on the BSE was US$1.63 trillion as of December 2010, making it the 4th largest stock exchange in Asia and the 8th largest in the world. The BSE has the largest number of listed companies in the world. As of June 2011, there are over 5,085 listed Indian companies and over 8,196 scrips on the stock exchange, the Bombay Stock Exchange has a significant trading volume. The BSE SENSEX, also called "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 the majority of the equity trading in India. While both have similar total market capitalization (about USD 1.6 trillion), share volume in NSE is typically two times that of BSE.

Bombay Stock Exchange Location of Bombay Stock Exchange in India

Type Location

Stock Exchange Mumbai, India

Founded Owner Key people Currency No. of listings

1875 Bombay Stock Exchange Limited Madhu Kannan (CEO & MD) Indian rupee ( ) 5,085

MarketCap Volume Indexes

US$1.8 trillion (Dec 2010)[1] US$231 billion (Nov 2010) BSE BSE BSE BSE 500 SENSEX Small Cap Mid-Cap

Website

www.bseindia.com

More

than 4000

Companies are

listed

in

BSE

or

Bombay

Stock

Exchange.

SENSEX, first compiled in 1986, was calculated on a "Market Capitalization-Weighted" methodology of 30 component stocks representing large, well-established and financially sound companies across key sectors. The base year of SENSEX was taken as 1978-79. SENSEX today is widely reported in both domestic and international markets through print as well as electronic media. It is scientifically designed and is based on globally accepted construction and review methodology. Since September 1, 2003, SENSEX is being calculated on a free-float market capitalization methodology. The "free-float market capitalization-weighted" methodology is a widely followed index construction methodology on which majority of global equity indices are based; all major index providers like MSCI, FTSE, STOXX, S&P and Dow Jones use the freefloat methodology. The growth of the equity market in India has been phenomenal in the present decade. Right from early nineties, the stock market witnessed heightened activity in terms of various bull and bear runs. In the late nineties, the Indian market witnessed a huge frenzy in the 'TMT' sectors. More recently, real estate caught the fancy of the investors. SENSEX has captured all these happenings in the most judicious manner. One can identify the booms and busts of the Indian equity market through SENSEX. As the oldest index in the country, it provides the time series data over a fairly long period of time (from 1979 onwards). Small wonder, the SENSEX has become one of the most prominent brands in the country.

SENSEX - Scrip Selection Criteria 1. Equities of companies listed on Bombay Stock Exchange Ltd. (excluding companies classified in Z group, listed mutual funds, scrips suspended on the last day of the month prior to review date, scrips objected by the Surveillance department of the Exchange and those that are traded under permitted category) shall be considered eligible 2. Listing History: The scrip should have a listing history of at least three months at BSE. An exception may be granted to one month, if the average free-float market capitalization of a newly listed company ranks in the top 10 of all companies listed at BSE. In the event that a company is listed on account of a merger / demerger / amalgamation, a minimum listing history is not required. 3. The scrip should have been traded on each and every trading day in the last three months at BSE. Exceptions can be made for extreme reasons like scrip suspension etc. 4. Companies that have reported revenue in the latest four quarters from its core activity are considered eligible. 5. From the list of constituents selected through Steps 1-4, the top 75 companies based on free-float market capitalisation (avg. 3 months) are selected as well as any additional companies that are in the top 75 based on full market capitalization (avg. 3 months). 6. The filtered list of constituents selected through Step 5 (which can be greater than 75 companies) is then ranked on absolute turnover (avg. 3 months). 7. Any company in the filtered, sorted list created in Step 6 that has Cumulative Turnover of >98%, are excluded, so long as the remaining list has more than 30 scrips. 8. The filtered list calculated in Step 7 is then sorted by free float market capitalization. Any company having a weight within this filtered constituent list of <0.50% shall be excluded 9. All remaining companies will be sorted on sector and sub-sorted in the descending order of rank on free-float market capitalization.

10. Industry/Sector Representation: Scrip selection will generally attempt to maintain index sectoral weights that are broadly in-line with the overall market. 11. Track Record: In the opinion of the BSE Index Committee, all companies included within the SENSEX should have an acceptable track record. 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 per se 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. SENSEX Calculation Methodology SENSEX is calculated using the "Free-float Market Capitalization" methodology, wherein, the level of index at any point of time reflects the free-float market value of 30 component stocks relative to a base period. The market capitalization of a company is determined by multiplying the price of its stock by the number of shares issued by the company. This market capitalization is further multiplied by the free-float factor to determine the free-float market capitalization. The base period of SENSEX is 1978-79 and the base value is 100 index points. This is often indicated by the notation 1978-79=100. The calculation of SENSEX involves dividing the freefloat market capitalization of 30 companies in the Index by a number called the Index Divisor. The Divisor is the only link to the original base period value of the SENSEX. It keeps the Index comparable over time and is the adjustment point for all Index adjustments arising out of

corporate actions, replacement of scrips etc. During market hours, prices of the index scrips, at which latest trades are executed, are used by the trading system to calculate SENSEX on a continuous basis.

Understanding Free-float Methodology Concept Free-float methodology refers to an index construction methodology that takes into 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, government holding, strategic holding and other lockedin 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. Subsequently all BSE indices with the exception of BSE-PSU index have adopted the free-float methodology. 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- -vis an investible index. This enables an apple-to-apple comparison thereby facilitating better evaluation of

performance of active managers. Being a perfectly replicable portfolio of stocks, a Freefloat adjusted index is best suited for the passive managers as it enables them to track the index with the least tracking error.

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. For example, under a Full-market capitalization methodology, companies with large market capitalization and low free-float cannot generally be included in the Index because they tend to distort the index by having an undue influence on the index movement. 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.

Globally, the Free-float Methodology of index construction is considered to be an industry best practice and all major index providers like MSCI, FTSE, S&P and STOXX 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 Freefloat Methodology. NASDAQ-100, the underlying index to the famous Exchange Traded Fund (ETF) - QQQ is based on the Free-float Methodology.

Definition of Free-float Shareholding of investors that would not, in the normal course come into the open market for trading are treated as 'Controlling/ Strategic Holdings' and hence not included in free-float. Specifically, the following categories of holding are generally excluded from the definition of Free-float:

Shares held by founders/directors/ acquirers which has control element

Shares held by persons/ bodies with "Controlling Interest"

Shares held by Government as promoter/acquirer

Holdings through the FDI Route

Strategic stakes by private corporate bodies/ individuals

Equity held by associate/group companies (cross-holdings)

Equity held by Employee Welfare Trusts

Locked-in shares and shares which would not be sold in the open market in normal course.

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. (Format available on www.bseindia.com). 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 0.55 means that only 55% of the market capitalization of the company will be considered for index calculation. Free-float Bands: % Free-Float Free-Float Factor >0 - 5% >5 - 10% >10 - 15% 0.05 0.10 0.15 % Free-Float Free-Float Factor >50 - 55% >55 - 60% >60 - 65% 0.55 0.60 0.65

>15 - 20% >20 - 25% >25 - 30% >30 - 35% >35 - 40% >40 - 45% >45 - 50%

0.20 0.25 0.30 0.35 0.40 0.45 0.50

>65 - 70% >70 - 75% >75 - 80% >80 - 85% >85 - 90% >90 - 95% >95 - 100%

0.70 0.75 0.80 0.85 0.90 0.95 1.00

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 day's closing price is taken for computation of Index closure. The use of Index Closure Algorithm prevents any intentional manipulation of the closing index value. 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 per se 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.

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. 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 BSE Indices.

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 (see 'Base Market capitalization Adjustment' below).

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.

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 buyback of shares, corporate restructuring etc.

Minimum Listing Requirements for New Companies The following eligibility criteria have been prescribed effective August 1, 2006 for listing of companies on BSE, through Initial Public Offerings (IPOs) & Follow-on Public Offerings (FPOs): 1. Companies have been classified as large cap companies and small cap companies. A large cap company is a company with a minimum issue size of Rs. 10 crore and market capitalization of not less than Rs. 25 crore. A small cap company is a company other than a large cap company. a. In respect of Large Cap Companies i. The minimum post-issue paid-up capital of the applicant company (hereinafter referred to as "the Company") shall be Rs. 3 crore; and ii. iii. The minimum issue size shall be Rs. 10 crore; and The minimum market capitalization of the Company shall be Rs. 25 crore (market capitalization shall be calculated by multiplying the post-issue paid-up number of equity shares with the issue price). b. In respect of Small Cap Companies i. The minimum post-issue paid-up capital of the Company shall be Rs. 3 crore; and ii. iii. The minimum issue size shall be Rs. 3 crore; and The minimum market capitalization of the Company shall be Rs. 5 crore (market capitalization shall be calculated by multiplying the post-issue paid-up number of equity shares with the issue price); and iv. The minimum income/turnover of the Company shall be Rs. 3 crore in each of the preceding three 12-months period; and v. vi. The minimum number of public shareholders after the issue shall be 1000.

A due diligence study may be conducted by an independent team of Chartered Accountants or Merchant Bankers appointed by BSE, the cost of which will be borne by the company. The requirement of a due diligence study may be waived if

a financial institution or a scheduled commercial bank has appraised the project in the preceding 12 months. 2. For all companies : a. In respect of the requirement of paid-up capital and market capitalization, the issuers shall be required to include in the disclaimer clause forming a part of the offer document that in the event of the market capitalization (product of issue price and the post issue number of shares) requirement of BSE not being met, the securities of the issuer would not be listed on BSE. b. The applicant, promoters and/or group companies, shall not be in default in compliance of the listing agreement. c. The above eligibility criteria would be in addition to the conditions prescribed under SEBI (Disclosure and Investor Protection) Guidelines, 2000.