PAPER NO-xxiii

REPORT OR PROJECT
ON

QUANTITY AND PRICE INDEX NUMBERS

IN NATIONAL ACCOUNT

SUBMITTED TO
SUBMITTED BY

DR. POONAM SETHI

DEEPAK

ROLL NO _____________

B.COM (H) 3rd YEAR

HINDU COLLEGE

DELHI UNIVERSITY
2 |Page
CERTIFICATE

It is certified that the Project Report entitled “Quantity and Price Index

Number in National Account” submitted by DEEPAK with Roll No.

________________ is his own work and has been carried out under my

supervision.

Mentor

Dr. POONAM SETHI

(Commerce Department)

(Hindu College, Delhi University)

i| Page
ACKNOWLEDGEMENTS

First and foremost, I would like to thank to my mentor of this project Dr.
POONAM SETHI for the valuable guidance and advice. She inspired us greatly to
work in this project. Her willingness to motivate us contributed tremendously to our
project. I also would like to thanks for her timely guidance in the conduct of our
project work which help me to complete this project work on time.

Besides, I would like to thank our Commerce Department for providing us

with a good environment and facilities to complete this project. Also, we would like to
take this opportunity to thank to the Hindu College of Delhi University for offering this
subject, B.Com (H). It gave us an opportunity to participate and learn about the
management system of the companies and increase ours knowledge about the
concern subject. Words are inadequate in offering my thanks to the Project Trainees
and Lab Assistant for their encouragement and cooperation in carrying out the
project work.

Finally, an honourable mention goes to my families and friends for their

understandings and supports on us in completing this project. Without helps of the
particular that mentioned above, we would face many difficulties while doing this
project.

DEEPAK

ii | P a g e
TABLE OF CONTENTS
CONTENTS PAGE NO

Certificate …………………………………………………………………………………….i
Acknowledgment ……………………………………………………………………………ii
Table of Contents …………………………………………………………………………..iii

1. INTRODUCTION
History of index number …………………………………………………………….1
Important definition ………………………………………………………………….2
Daily use of index numbers ………………………………………………………...3
Problems in the construction of index ……………………………………………..4

2. METHOD OF CONSTRUCTING INDEX NUMBERS

Price index number............................................................................................6
Un-weighted index number................................................................................6
Weighted index number…………………………………………………………….8
Quantity and volume index numbers …………………………………………….11

3. INDEX NUMBER OF INDUSTRIAL PRODUCTION

Meaning ……………………………………………………………………………..12
Origin and history…………………………………………………………………...13
Successive Revisions……………………………………………………………...13
Revised Series of IIP with Base Year 1993-94 …………………………………14

4. SHARE PRICE INDICES

Bombay Stock Exchange …………………………………………………………17
SENSEX - Scrip Selection Criteria……………………………………………….18
SENSEX Calculation Methodology………………………………………………19
Maintenance of SENSEX …………………………………………………………19
Adjustment for Bonus, Rights and Newly Issued Capital ……………………...20
Free Float Methodology …………………………………………………………...21
Total Return Index (Nifty)………………………………………………………….22

5. CONCLUSION………………………………………………………………………….24

6. BIBLIOGRAPHY………………………………………………………………………..25

iii | P a g e
iv | P a g e
CHAPTER-1
INTRODUCTION

1.1 History of Index Number

No clear consensus has emerged on who created the first

price index. The earliest reported research in this area came from Welshman Rice
Vaughan who examined price level change in his 1675 book A Discourse of Coin
and Coinage. Vaughan wanted to separate the inflationary impact of the influx of
precious metals brought by Spain from the New World from the effect due to
currency debasement. Vaughan compared labour statutes from his own time to
similar statutes dating back to Edward III. These statutes set wages for certain tasks
and provided a good record of the change in wage levels. Vaughan reasoned that
the market for basic labour did not fluctuate much with time and that a basic
labourer’s salary would probably buy the same amount of goods in different time
periods, so that a labourer’s salary acted as a basket of goods. Vaughan's analysis
indicated that price levels in England had raised six to eightfold over the preceding
century. [1]

While Vaughan can be considered a forerunner of price index research, his analysis
did not actually involve calculating an index. In 1707 Englishman William Fleetwood
created perhaps the first true price index. An Oxford student asked Fleetwood to
help show how prices had changed. The student stood to lose his fellowship since a
fifteenth century stipulation barred students with annual incomes over five pounds
from receiving a fellowship. Fleetwood, who already had an interest in price change,
had collected a large amount of price data going back hundreds of years. Fleetwood
proposed an index consisting of averaged price relatives and used his methods to
show that the value of five pounds had changed greatly over the course of 260
years. He argued on behalf of the Oxford students and published his findings
anonymously in a volume entitled CHRONICON PRECIOSUM.

1 |Page
1.2 Important Definition

Some of important definitions of index number are given below:

1. “An index number is a statistical measures designed to show change in a

variable or group of variable with respect to time, geographical location or
other characteristics such as income, profession, etc.”

……..SPIEGEL

2. “Index numbers are devices for measuring differences in magnitude of a

group of related variables.”

……... CROXTON & COWDEN

3. “In its simplest form, an index number is nothing more than a relative number,
or a “relative” which express the relationship between two figures, where one
of the figure is used as a base”

………MORRIS HAMBURG

4. “In its simplest form, an index number is the ratio of two index number
expressed as a per cent. An index number is a statistical measures designed
to show changes in the variables or in a group of related variables over time,
or with respect of geographic location, or other characteristics.”

………PATTERSON

From above definitions it is clear that an index number is a specialized average

designed to measures the change in a group of relative variables over a period of
time. Thus when we say that the index number of wholesale prices is 112 for July
2010 it means there is net increase in the price of wholesale commodities to the
extent of 12 per cent during the year.
However it should be noted that index number not only measures
changes over the period of time but it also compare economic conditions of different
locations, different industries, different cites or different countries.

2 |Page
1.3 Daily Use of Index Numbers
Index numbers have become one of the most widely used
statistical devices and there is hardly any field where they are not used. Newspaper
headline the fact that price are going up or down , that industrial production rising or
falling , that imports are increasing or decreasing ,that crime are rising in a particular
period compared to the previous period as disclosed by index numbers. They are
used to pulse of economy and they have come to be used as indicator of inflationary
or deflationary tendencies. In fact, they are described as barometer of economic
activities, i.e., if one wants to get an idea as to what is happening in an economy he
should look to important indices like the index number of industrial production,
agriculture production, business activities, etc.

Index numbers are indispensable tool of economic activities and business analysis.
Their uses can be show by the following points:

1. They help in framing suitable policies. Many of the economic and business
polices are guided by index numbers. For example, while deciding the
increase in dearness allowance of the employees, the employers have to
depend upon the cost of living index. If wages and salaries are not adjusted in
accordance with the cost living, very often its lead to strikes and lock-outs
which in turns cause considerable wastes of resources.

2. They reveal trend and tendencies. Since index numbers are most widely
used for measuring changes over a period of time series so formed enable us
to study general trend of the phenomenon under study. For example, by
examining index numbers of import for India for last 10 years we can say our
import are showing upward tendency, i.e., they are rising year after year.

3. Index numbers are useful in deflating . Index numbers are highly useful in
deflating they are used to adjust the original data for price change, or to adjust
wages for cost of living changes and thus transforms nominal wages into real

3 |Page
 wages. Moreover, nominal income can be transforms into real income and
nominal sales into real sales through appropriate index numbers.

4 |Page
1.4 Problems in the Construction of Index Numbers:

Before constructing index numbers a careful thought must be given to the following
problems:

1. The purpose of Index.

The purpose of constructing the index number must be very clearly decided.
There is no all-purpose index. Every index is of limited and particular use.
Thus, a price index that is intended to measures the cost or living of poor
families, great care should be taken out to include goods ordinarily used by
middle class and upper class groups. Failure to deicide clearly the purpose of
the index would lead to confusion and wastage of time with no fruitful result.

2. Selection of base period.

Whenever index numbers are constructed a reference is made to some base

period. The base period of an index number is the period against which
comparison is made. It may be a year, a month or a day. The index for base
period is always taken as 100. Though the selection of the base period would
primarily depends upon the object of index.

3. Selection of number of items.

The items included in index should be determined by the purpose for which
the index is constructed. Every item cannot be included while constructing
index it is necessary to decide what commodity to include.

4. Price quotations.

After the commodity has been selected, the next problem is to obtain price
quotation for these commodities. Price of many commodities varies from
place to place and even from shop to shop in the same market. A selection
must be made of representative places and person.

5. Choice of average.

Since index numbers index are specialized averages a decision has to made
as to which particular (i.e., mean, median, mode, geometric mean or harmonic

5 |Page
 mean) should be used for constructing the index. Median, mode and mean
are almost never used in the construction of index. Basically, a choice has to
be made between arithmetic mean and geometric mean.

6. Selection of appropriate weights.

The problem of selecting weights is quite important and at same time difficult
to decide. The term “weight” refers to the relative importance of the different
items in construction of the index. All the items are not of equal importance
and hence it is necessary to used suitable method whereby the varying
importance of the different items be taken into account.

7. Selection of appropriate formula.

A large number of formulae have been available for constructing the index.
The problem very often is that of selecting the most appropriate formula. The
choice of the formula would depend not only on the purpose of the index but
also on data available.

6 |Page
CHAPTER-2
METHODS OF CONSTRUCTING
INDEX NUMBER

2.1 Price index number

A large number of formulae are devised for constructing index numbers. They are
grouped under two heads:

a. Un- Weighted Indices; and

b. Weighted Indices.

In the un-weighted indices weights are not expressly assigned whereas in the
weighted indices weights are assigned to various items. Each of these types may be
further divided under two heads:

i. Simple aggregative, and

ii. Simple average of relatives.

The chart shows the various methods:

2.2 Un-Weighted Index Numbers

I. Simple Aggregative.

This is the simplest method of constructing index. When this method is used to
construct a price index the total of current year prices for the various commodities in
question is divided by the total of base year prices and the quotient is multiplied by
100. Symbolically:

= total of current year prices for various commodities.

7 |Page
 = total of base year prices for various commodities.

Limitations of this index: There are two main limitations of the simple aggregative
index:

1. The unit used in the price or quantity quotation can exert a big influence on
the value of the index.
2. No consideration is given to the relative important of the commodities.

This index is based on the assumption that is based on that the

various items and their prices are quoted in the same unit. If the unit of measurement
is different for different items, the index shall producer vastly divergent result.
Manipulations are thus possible to suit one’s requirements by quoting prices per kg
rather than per pound rather than per quintal, and so on. Any index whose value can
be manipulated in this 8/manner can hardly be used as an objective measure.
Moreover, equal importance is given to all the items which are wrong. It is for these
reasons that simple aggregative index has never gained any great degree of
acceptance.
II. Simple Average of Relatives.

When this method is used to construct a price index, first of all price relatives are
obtain from the various items included in the index and then average of these
relatives is obtained using any one of the measure of central value. When arithmetic
mean is used for averaging the relatives the formula for computing the index is

Where N refers to the number of items whose price relatives are thus averaged.

Although any measures of central value can be used to obtain the overall index,
price relatives are generally averaged either by the arithmetic or the geometric
mean. When geometric mean is used for averaging the price relatives the formula for
the index becomes

Or where

8 |Page
Other measures of central value are not in common use for averaging relatives.

2.3 Weighted index numbers

The so-called un-weighted index discussed is not un-weighted in the true sense of
the term. They assign equal importance to all the items included in the index and as
such they are in reality weighted, weights being implicit rather than explicit.
Construction of index requires a conscious effort to assign to each commodity weight
in accordance its importance in the total phenomenon that the index is supposed to
describe.

I. Weighted Aggregative Indices:

These indices are of the simple aggregative type with the fundamental difference
that weights are assigned to the various items included in the index. There are
various methods of assigning weights and consequently a large number of formulae
for constructing index have been devised of which some of most important methods
are:

1. LASPEYRES Method:

The LASPEYRES price index is a weighted price index, where the weights are
determined by quantity in the base period. The formula for constructing the index is:

LASPEYRES index attempts to answer the question: “what is the change in

aggregate value of the base period list of the goods when the valued at given period
of prices?” This index is widely used in practical work.

2. PAASCHE’S Method:

The PAASCHE price index is a weighted aggregate price index in which the weights
are determined by the quantity in the given year. The formula for constructing the
index is:

9 |Page
In general, this formula answers the question: “what would be the value of the given
period list of goods when valued at base period prices?”

3. DORBISH and BOWELY Method:

DORBISH and BOWELY have suggested simple arithmetic mean of the two index
that is LASPEYRES and PASSCHE so as to take into account the influence of both
the periods, i.e., current as well as base period. The formula for constructing the
index is:

Where L = LASPEYRES index, P = PASSCHE index

Or

4. FISHER’S ‘ideal’ index:

Prof. Irving Fisher has given a number of formulae for constructing index and of
these he calls one as the ‘ideal’ index. The Fisher’s Ideal index is given by the
formula:

It shall clear from the formula that fisher’s Ideal index is a geometric mean of the
LASPEYRES and PASSCHE indices. Thus in the Fisher’s Method we average
geometrically formulae that err in opposite directions.

5. MARSHALL-EDGEWORTH Method:

In this method also the current year as well as base year prices and quantities are
considered. The formula for constructing the index is:

10 | P a g e
Or opening the brackets

It is simple, readily constructed measures, giving a very close approximately to the

results obtained by the ideal formula.

6. KELLY’S Method:

Truman L. Kelly has suggested the following formula for constructing the index:

Here weights are the quantities which may refers to some period, not necessarily the
base year or the current year. Thus the average quantity of two years may be used
as a weights, the formula becomes:

Similarly, the average of the quantities of three or more year can be used as weights
this method is known as fixed weight aggregative index and in currently in great
favour in the construction of index series.

II. Weighted Average of Relatives:

In this methods discussed above price relatives were not computed. However, like
un-weighted relative method it is also possible to compute weighted average of
relatives. For purpose of averaging we may use either the arithmetic mean or the
geometric mean. The steps in the construction of the weighted arithmetic mean of
the relative’s index number are as follows:

i. Express each items of the period for which the index is being
calculated as per cent age of the same items in the base period.

11 | P a g e
 ii. Multiply the percentage as obtained in step (i) for each item by the
weight which has been assigned to that item.

iii. Add the result obtained from the several multiplications carried out in
step (ii).

iv. Divide the sum obtained in step (iii) by the sum of the weights used.
The result is the index number. Symbolically,

V = Value Weights, i.e.

Instead of using arithmetic mean the geometric mean may be used for averaging
relatives. When geometric mean is used the formula for computing the index is:

And V = value weights, i.e.

This is weighted geometric mean of relative’s index numbers.

2.4 QUANTITY AND VOLUME INDEX NUMBERS

Price index numbers measures and permit comparison of the price of certain goods;
quantity index number. On the other hand, measure the physical volume of
production, construction or employment. Though price indices are more widely used,
production indices are highly significant as indicator of the level of output in the
economy or in any part of it.

In constructing of quantity index number, the problems confronting the statistician

are analogous to those involved in the price indices. We measure the quantity, and
when we weigh we used price or value as weights. Quantity indices can be obtained
easily by changing p to q and q to p in the various formula discussed in price index.

Thus, when LASPEYRES method is used

12 | P a g e
When PAASCHE’S formula is used

When FISHER’S formula is used

These formulae represent the quantity index in which the quantities of the different
commodities are weighted by their price. However, any other suitable weights can be
used instead.

13 | P a g e
CHAPTER-3
INDEX NUMBER OF INDUSTRIAL
PRODUCTION
The index number of industrial production is designed to measures increase or
decrease in the level of industrial production in a given period compared to some
base period. It should be noted that such an index measures change in the quantum
of production and not in values. For constructing such index it is necessary to obtain
data about the level of industrial output in the base period and in given period.
Usually data about production are collected under the following heads:

1. Textile industries – cotton, woollen, silk, etc.

2. Mining industries – iron ore, coal, copper, petroleum, etc.

3. Metallurgical industries – iron and steel.

4. Mechanical industries – locomotive, ships, aeroplanes, etc.

5. Industries subject to excise duties – sugar, tobacco, match, etc.

6. Miscellaneous – glass, soap, chemical, cement, etc.

3.1 Meaning

Index of Industrial Production (IIP) in simplest terms is an index which details

out the growth of various sectors in an economy. E.g. Indian IIP will focus on sectors
like mining, electricity, Manufacturing & General. Also base year needs to be decided
on the basis of which all the index figures would be arrived at. In case of India the
base year has been fixed at 1993-94 hence the same would be equivalent to 100
Points

Index of Industrial Production (IIP) is an abstract number, the magnitude of which

represents the status of production in the industrial sector for a given period of time
as compared to a reference period of time It is a statistical device which enables us

14 | P a g e
to arrive at a single representative figure to measure the general level of industrial
activity in the economy. Strictly speaking the IIP is a short term indicator measuring
industrial growth till the actual result of detailed industrial surveys become available.
This indicator is of paramount importance and is being used by various organisations
including Ministries/Departments of Government of India, Industrial Associations,
Research Institutes and Academicians.

3.2 Origin and History

In India, the first official attempt to compute regularly the Index of Industrial
Production was made much earlier than even the recommendations on the subject at
the international level by UNSO. The Office of Economic Advisor, Ministry of
Commerce and Industry made the first maiden attempt of compilation and release of
Index of Industrial Production with base year 1937 covering 15 important industries
accounting for more than 90% of the total production of the selected industries.
Subsequently, the base years were revised twice, viz., in 1946 and 1951.With the
inception of Central Statistical Organisation (CSO) in 1951, the responsibility for
compilation and publication of the Index of Industrial Production (IIP) was vested with
this office. The general scope of the index of industrial production as recommended
by the United Nations Statistical Office (UNSO) is defined to include mining,
manufacturing, construction, electricity and gas sectors. But due to constraints of the
data availability, the present general index of industrial production compiled in India
has in its scope mining, manufacturing and electricity only.

As the structure of industrial sector changes over time, it becomes necessary to

revise the IIP periodically, so as to measure the real growth in the industrial sector.
UNSO recommends that the base year of the IIP may be revised quinquennially. It
has been revised from time to time by shifting the comparison base to a recent
period, by reviewing the coverage of items and industries and by improving as far as
practicable, the technique of construction with a view to reflect adequately the
industrial growth and structure. When the index was commenced in India, the base
year adopted was 1937 and this was revised successively to 1946, 1951, 1956,
1960, 1970, 1980-81 and 1993-94.

3.3 Successive Revisions

15 | P a g e
 As the structure of the industrial sector changes over time, it became
necessary to revise the base year of the IIP periodically to capture the changing
composition of industrial production and emergence of new products and services so
as to measure the real growth of industrial sector (UNSO recommends quinquennial
revision of the base year of IIP). After 1937, the successive revised base years were
1946, 1951, 1956, 1960, 1970, 1980–81 and 1993-94. Initially it was covering 15
industries comprising three broad categories: mining, manufacturing and electricity.
The scope of the index was restricted to mining and manufacturing sectors
consisting of 20 industries with 35 items.

The latest series with 1993-94 as the base year containing 543 items (with the
addition of 3 items for mining sector and 188 for the manufacturing sector) has come
into existence on 27 May 1998 and ever since, the quick estimates of IIP are being
released as per the norms set out for the IMF’s SDDS2, with a time lag of six weeks
from the reference month. These quick estimates for a given month are revised twice
in the subsequent months. To retain the distinctive character and enable the
collection of data, the source agencies proposed clubbing of 478 items of the
manufacturing sector into 285 item groups and thus making a total of 287 item
groups together with one each of electricity and mining & quarrying. The revised
series has followed the National Industrial Classification NIC-1987. Another
important feature of the latest series is the inclusion of unorganised manufacturing
sector (That is, the same 18 SSI products) along with organised sector for the first
time in the weighting diagram.

3.4 Revised Series of IIP with Base Year 1993-94:

Technical Advisory Committee

The Technical Advisory Committee (TAC) which had been set up in the
Department of Statistics in June, 1995 to advise on Compilation of Comparable State
IIPs and Composite all-India IIP was also entrusted subsequently in November 1996
with the responsibility of examining all the issues and providing technical guidance in
the matter of shifting the base year of all-India IIP to 1993-94. The salient features of
the recommendations of the TAC in this regard are as under:-

16 | P a g e
 a. The current series of all-India IIP may be revised by shifting its base to 1993-
94;

b. Recognising the contribution of the unorganised sector, the weighting diagram

of the revised series should take into account the total production of both the
organised and unorganised manufacturing sectors.

c. In view of the difficulties in lining up item-wise monthly production data for

small scale items, the selection of items may be based only on the detailed
results of ASI 1993-94, as has also been the practice in the past. At least 18
items of small scale sector included in the present series may be considered
for inclusion in the new series;

d. The item basket for the revised series of all-India IIP with base 1993-94 may
be selected in a similar manner as recommended for selection of State level
item basket i.e., the selected items should account for nearly 80% of the total
output for the manufacturing sector. However the criteria may be used with
certain flexibility. For example, items not accounting for a gross annual
production of 80 crore may not necessarily be included in the basket. The
criteria may be relaxed, if necessary, to ensure that the provisionally selected
items in all the 2-digit industry groups captured at least 60% of the Value of
Output of the particular group. The over-riding criteria for finalisation of item
basket would be the regular flow of monthly production data from the source
agencies.

e. The revised series would follow the National Industrial Classification (NIC)
1987.

f. Gross Value of Output (GVO) rather than Gross Value Added (GVA) may be
used for weighting purposes from sectorial (1-digit) to the ultimate (4-digit)
levels of industry for compilation of both the State IIPs as well as all-India IIP.

Most of the recommendations of the TAC were accepted. However, the use of GVO
as weights at industry group levels was not accepted for Compiling the All India IIP
and GVA was continued to be used as in the 1980-81 series.

Scope and coverage:

17 | P a g e
 The scope of the index has been confined to mining, manufacturing and
electricity sectors and does not cover gas, water supply and construction. The
distribution of items covered by the index with 1980-81 and 1993-94 base years are
as follows:-

No. of Items

Sector 1980-81 1993-94

Mining 61 64

Manufacturing 288 478

Electricity 1 1

Total 350 543*

*(clubbed into 287 item groups: Mining-1, Mfg. - 285, Electricity - 1)

18 | P a g e
CHAPTER-4
SHARE PRICE INDICES

4.1 BOMBAY STOCK EXCHANGE (BSE)

The first organised stock exchange was established in July 1875 as an

association of native brokers, name as Native Share and Stock Broker Association.
Its formed deed of association was executed in 1875. This stock exchange is now
properly known as the Bombay Stock Exchange (BSE). This stock exchange played
a significant role during the phase of recovery from several years of depression. It
was the first to be recognised by the government of India.

The Governing Board having 20 directors is the apex body, which decides polices
and the affairs of the exchange. The Governing Board consists of 9 elected directors,
who are the broking community, three SEBI nominees, six public representatives
and an Executive director & Chief Executive Officer and a Chief Operative Officer.

BSE SENSEX

Bombay Stock Exchange (BSE) SENSEX is the most widely used and accepted
equity price Index in the country, with the base year as 1978-79, it comprise of 30
scrip representative a sample of large, well-established and financially sound
companies. Popularly known as SENSEX, the index has been serving a large
measure, the purpose of quantifying the price movement as also the sensitivity of the
market in an effective manner.

The Sensex is supposed to mirror the happening on the BSE. Just as you check only
couple of mangoes in a basket to decide whether is the entire lot is good, so will you
check out the Sensex to get a sense of what is happening in the stock market?
Being the oldest index in India it has also attains a position of pre-eminence in the
mind of Indian investors.

The objectives of index are:

19 | P a g e
 1. To measure market movement: Giving its long history and wide acceptance,
no other Index matches the BSE Sensex in reflecting market movement and
sentiments. Sensex is widely used to describe the mood of Indian market.

2. Benchmark of funds’ performance: The inclusion of blue chip and the wide
and balanced industries representation in the Sensex makes it the ideal
benchmark for fund managers to compare the performance of their funds.

Industrial investors, money managers and small investors all refer to the BSE
Sensex for their specific purpose. The BSE Sensex is in effect the proxy for the
Indian stock markets. The country’s first derivative product, i.e., index- feature was
launched on BSE Sensex.

4.2 SENSEX - Scrip Selection Criteria

The general guidelines for selection of constituents in SENSEX are as follows:

1. Listed History: The scrip should have a listing history of at least 3 months at
BSE. Exception may be considered if full market capitalization of a newly listed
company ranks among top 10 in the list of BSE universe. In case, a company is
listed on account of merger/ demerger/ amalgamation, minimum listing history would
not be required.

2. Trading Frequency: 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.

3. Final Rank: The scrip should figure in the top 100 companies listed by final rank.
The final rank is arrived at by assigning 75% weightage to the rank on the basis of
three-month average full market capitalization and 25% weightage to the liquidity
rank based on three-month average daily turnover & three-month average impact
cost.

4. Market Capitalization Weightage: The weightage of each scrip in SENSEX

based on three-month average free-float market capitalization should be at least
0.5% of the Index.

20 | P a g e
 5. Industry/Sector Representation: Scrip selection would generally take into
account a balanced representation of the listed companies in the universe of BSE.

6. Track Record: In the opinion of the BSE Index Committee, the company should
have an acceptable track record.

4.3 SENSEX Calculation Methodology

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 free-float methodology.

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.

4.4 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.

21 | P a g e
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.

4.5 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

22 | P a g e
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.

• Base Market capitalization Adjustment

The formula for adjusting the Base Market capitalization is as follows:

To illustrate, suppose a company issues right shares which increases the market
capitalization of the shares of that company by say, Rs.100 crores. The existing
Base Market capitalization (Old Base Market capitalization), say, is Rs.2450 crores
and the aggregate market capitalization of all the shares included in the index before
the right issue is made is, say Rs.4781 crore. The "New Base Market capitalization”
will then be:

This figure of Rs. 2501.24 crore will be used as the Base Market capitalization for
calculating the index number from then onwards till the next base change becomes
necessary.

4.6 Free Float -----A Globally Accepted Indexing Methodology

From 1ST September 2003, the country’s equity benchmark Sensex is being
calculated based on the Free Float methodology. Prior to 1-9-2003, the Sensex was
calculated based on full market capitalisation methodology.

Internationally, all the major index providers have shifted to the Free Float
methodology. MSCI, a leading global Index provider, shifted all its indices to the
Free-float methodology, in 2002. The MSCI Indian Standard Index, which is followed
by FIIS to track Indian equities, is also based on the free-float methodology.
NASDAQ-100, the underlying index to the famous ETF-QQQ is based on Free-float
methodology. FTSE, Dow Jones, S&P, STOXX and other index providers are also
using the free-float methodology.

23 | P a g e
Free-float Indices in India

Currently there are two indices based on Free-float methodology, BSE TECK
Index, launched in July 2001, was the country’s first Free-float index. On 16TH June
2003, BSE launched BANKEX, a benchmark for the banking sector stock also based
on the Free-float methodology.

BSE and the Determination of the Free-float Factor

BSE has designed the detailed Free-float format to be filled and summited by all
index companies on a quarterly basis with the exchange. The exchange determines
the free-float factor for each company based on the detailed information submitted
by the companies. Free-float factor is the multiple with which total market
capitalisation of a company is adjusted to arrive at the free-float market
capitalisation. Once the free-float factor of accompany is calculated, it is rounded-off
to the higher multiple of 10 the free-float factor of the company is categorised into
one of the bands given in diagram. The banding structure reduces the potential
frequent changes in the Free-float factor of index companies. A Free-float factor of
say 0.6 means that only 60% of market capitalisation of the company will be
considered for Index calculation.

4.7 Total Return Index (Nifty)

Nifty is the price index and hence reflects the returns one would earn if investment is
made the index portfolio. However, a price index does not consider the return arising
from dividend receipt. Only capital gains arising due to price movements or
constituent stocks indicated in price index. Therefore, to get a true picture of return,
the dividend received from the constituent stock also need to be factored in the index
values. Such an index, which includes the dividends received, is called the total
return index

Total return index reflects the return on the index arising from constituent stock
movement and dividend receipts from constituent index stocks.

Methodology for Total Return Index (TR) is as follows:

24 | P a g e
The following information is as prerequisite for calculation of TR Index: (1) Price
Index close, (2) Price Index return, (3) Dividend pay-out in Rupees, (4) Index Base
Capitalisation on ex-dividend date.
Dividend pay-outs as they occur are indexed on ex-date.

Indexed dividends are then reinvested in the index to the given TR Index.

Base for both the Price index close and TR Index close will be the same. An investor
in index stock should benchmark his investment against the Total Return Index
instead of the price index to determine the actual return on the index.

25 | P a g e
CONCLUSION
Index numbers are convenient devises for measuring relative changes of differences
from time to time or from place to place. Just as the arithmetic mean is used to
represent a set of values, an index number is used to represent a set of values over
two or more different period or locations.

The basic device used in all method of index number construction is to be average
the relative change in either quantities or prices since relatives are comparable and
can be added even though the data from which they were derived cannot
themselves be added. For example, if wheat production is gone up to 110% of the
previous year’s production and cotton production has gone up to 105%; it is possible
to average the two percentages as they have gone up by 107.5%. This assumes that
both have equal weights; but if wheat production is twice as important as cotton,
percentage should be weighted 2 and 1. The average relatives obtained through this
process are called index numbers.

An index number is a ratio or an average of ratios expressed as a percentage, two or

more time periods are involved, one of which is the base time period. The value at
the base time period serves as the standard point comparison.
An index time series is a list of index numbers for two or more time period of time,
where each index number employs the same base year.

Relatives are derived because absolute numbers measured in some appropriate

unit, are often of little importance and meaningless in themselves. If the meaning of
the relative figure remains ambiguous, it is necessary to know the absolute as well
as the relative number.

Index numbers are studied for making forecasts or inferences about the figure are
applied in the term of index numbers. In regression analysis, either the independent
or dependent variable or both may be in the form of index numbers. They are less
unwieldy than large numbers and are readily understandable.

These are of two broad types: simple and composite. The simple index is computed
for one variable whereas the composite is calculated from two or more variables.
Most of index numbers are composite in nature.

26 | P a g e
Bibliography

Books

Gupta S.P., and Archana Gupta, Statistical Method, 7th Ed., Sultan Chand & Sons,
New Delhi, 2007, pp. 9.1-9.15.

Levin, Richard and David S. Rubin, “Statistics for Management”, 7th Ed., Prentice
Hall of India.

Siegel, Andrew F., “Practice of Business Statistics”, 4th Ed., Irwin McGraw Hill.

Gupta, S.C., “Fundamental of Statistics”, Himalaya Publishing House.

Frank, Harry and Steven C. Althoen, “Statistics: Concept and Applications”,

Cambridge Low-priced Editions, 1995.

Spiegel M.D., “Theory and Problems of Statistics”, Schaum’s Outlines Series,

McGraw Hill Publication Co.

Web Site

www.encyclopedia.com/ -

www.wikipedia.org/ -

www.bseindia.com/ -

www.investopedia.com/-

www.thehindubusinessline.com/-

unstats.un.org/unsd/industry/docs/F1.pdf/-

dacnet.nic.in/eands/Appendix%20II.pdf /-

27 | P a g e
28 | P a g e