Stock market index

A stock market index is a way of measuring performance of certain stocks in stock market. Stock market index by itself is not such an important number. What is important is the change from an original or base value. An up or down movement gives an indicator of how the particular segment of stock that the index covers is performing and thus how the overall stock market is performing. The index may be weighted to reflect the market capitalization of its components, or may be a simple index which merely represents the net change in the prices of the underlying instruments. Usually the index value is termed points as in The KSE dropped 500 points today. This means that the index went from a value of perhaps 4000 points to a value of 3500 points. The points dont mean anything the best way to look at an index number is to compare it with a previous value such as the previous days number. If you invest in mutual funds or individual stocks then its important to measure the performance of your investments against a relevant market index. If your investments consistently lag behind the index then it might be time to come up with a new investing strategy.

Different Types of Stock Market Indexes

1. Market Value-Weighted Index The most common type of index is called market value-weighted index, also called a capitalizationweighted index. What this means is that the index measures the total value of all the outstanding stock issued by the various companies in the index. The reasoning behind a market value index such as the S&P 500*, is that companies with larger market capitalizations or value will have a larger weighting in the index and will count more than smaller companies. It would not make sense for a very small company to have the same weighting in an index as a large company such as IBM. One of the drawbacks of a market-weighted index is that sometimes one company or one type of industry can make up a very large portion of the index. In the technology bubble of the late 90s, the tech portion of most broad based indices became quite dominant. 2. Price-Weighted Index Another less common type of index is called price-weighted. The Dow Jones Industrial Average is the most famous example of a price-weighted index. This means that the index is calculated using a stock price instead of the company value. The big problem with this type of index is that a company that has a stock price of $100 will count twice as much as a company with a stock price of $50. There is a formula used to calculate these types of indices to account for stock splits. In actual fact the S&P 500 index is a float-weighted index which for our purposes very similar enough to market-weighted.

3. Free Float weighting: Free-Float calculation can be used to construct stock indices for better market representation than those constructed on the basis of total market capitalization of companies. It gives weight for constituent companies as per their actual liquidity in the market and is not unduly influenced by tightly held large-cap companies.

Calculation methodology:
1. Price weighted index:
In price weighted index method index value is calculated based on the price of constituent stock. So the value of index by this method = (800 + 450 + 420 + 500 + 820) * 1000 / (150 + 300 + 450 + 70 + 270) = 2990 * 1000/1240 = 2411

2. Market capitalization weighted index:

In this method of calculation each company is given weight according to their market capitalization. So the higher the market capitalization of a constituent higher is its weight in the index. A base value will be taken to calculate present value of the index. Usually this base value corresponds to prices of the constituent stocks on a particular historic date. For this example, say as at Dec. 2001. Take the base value as 1000.
Stock price as at Dec. 2001 150 300 450 70 270 No. of in million 20 12 16 30 8 shares Stock price as at Dec. 2012 800 450 420 500 820

SL.No 1 2 3 4 5

Stock Name ABC DEF GHI JKL MNO

Market capitalization= No. of Shares* Market Price Sum of the market capitalization of all constituent stocks as at Dec. 2001 = (150*20 + 300*12 + 450*16 + 70*30 + 270 *8) = Rs 18,060 million. Sum of the market capitalization of all constituent stocks as at Dec. 2012 = (800*20 + 450*12 + 420*16 + 500*30 + 820 *8) = Rs 49,680 million. Now the value of the index as per market cap weight = (49680*1000/18060) = 2750

3. Free Float Calculation:

Total Outstanding Shares Less: Shares held by Directors/sponsors Government Holdings as promoter/acquirer/ Controller Shares held by Associated Companies (Cross holdings) Shares held with general public in Physical Form XXX XXX _______ Free-Float: XXX XXX XXX XXX XXX

Stock Market Indices in Pakistan

1) TRADABLE BANKS INDEX
Banking Sector plays vital roles in Pakistans economy and therefore KSE has developed a Tradable Banks index which tracks at least 80% free-float market capitalization of the Banking Sector. This index provides Investors and Market Intermediaries with an appropriate benchmark that captures the performance of each segment of the economy. The primary objective of the Tradable Banks index is to have a benchmark by which the stock price performance of the Banking Sector can be measured and compared over a period of time. This index is designed to provide investors with a depiction (representation) of the sector and their performance in Pakistans equity market. Globally, the Free-float Methodology of index construction is considered to be an industry best practice and all major index providers like MSCI, FTSE and S&P have adopted the same. MSCI, a leading global index provider, shifted all its indices to the Free-float Methodology in 2002. Tradable Banks index is calculated using the Free-Float Market Capitalization methodology. The freefloat methodology refers to an index construction methodology that takes into account only the market capitalization of free-float shares of a company for the purpose of index calculation.

PRE - REQUISITES FOR INCLUSION The Company which is on the Defaulters Counter and/or its trading is suspended, declared NonTradable (i.e. NT) in preceding 6 months from the date of re-composition or which is in the process of de-listing or is on the non-compliant segment shall not be considered for inclusion in KSE-Tradable Banks index The Company will be eligible for KSE-Tradable Banks index if its securities are available in the Central Depository System The Company should have a formal listing history of at least six months on KSE; The company must have an operational track record of at least one financial year and it should not be in default(s) of the Listing Regulations; The Company should have minimum free-float shares of 10% of total outstanding shares or 30 million free-float shares.

*Pre-requisite = something that must exist or happen before something else can happen. * Central Depository System = A computer system that is used by Exchanges and brokerage houses to facilitate the exchange of securities

2) TRADABLE OIL & GAS INDEX

Oil & Gas Sector plays vital roles in Pakistans economy and therefore KSE has developed a Tradable Oil & Gas Index. This index provides Investors and Market Intermediaries with an appropriate benchmark that captures the performance of each segment of the economy. The primary objective of the Tradable Oil & Gas Index is to have a benchmark by which the stock price performance of the Oil & Gas Sector can be gauged and compared over a period of time. This index is designed to provide investors with a depiction of the breath of the sector and their performance in Pakistans equity market. Tradable Oil & Gas Index is calculated using the Free-Float Market Capitalization methodology. PRE - REQUISITES FOR INCLUSION The Company which is on the Defaulters Counter and/or its trading is suspended, declared NonTradable (i.e. NT) in preceding 6 months from the date of re-composition or which is in the process of de-listing or is on the non-compliant segment shall not be considered for inclusion in KSE-Tradable Oil & Gas Index The Company will be eligible for KSE-Tradable Oil & Gas Index if its securities are available in the Central Depository System The Company should have a formal listing history of at least six months on KSE; The company must have an operational track record of at least one financial year and it should not be in default(s) of the Listing Regulations; The Company should have minimum free-float shares of 10% of total outstanding shares or 30 million free-float shares.

3) KMI:
The objective of KSE-Meezan Index (KMI) is to serve as a gauge for measuring the performance of Shariah compliant equity investments. It may also act as a research tool for strategic asset allocation process. Besides tracking performance of Shariah compliant equities, its construction will increase investor trust and enhance their participation. Currently, the three indices being maintained at the Karachi Stock Exchange are KSE-100 Index, KSE All-Share Index, and KSE-30 Index. The KSE-100 and KSE All Share Indices are market capitalization indices while KSE-30 Index is based on free-float capitalization. ELIGIBILITY CRITERIA

Shariah Screening Filters

For any stock to be Shariah compliant, it must meet ALL six criteria given below: 1. Screening Criteria # 1: Business of the Investee Company The core business of the company should not violate any principle of Shariah. Therefore, it is not permissible to acquire the shares of the companies providing financial services on interest like conventional banks, insurance companies, leasing companies or the companies involved in some other business not approved by the Shariah e.g. Companies making or selling liquor, pork, haram meat, or involved in gambling, or any other impermissible activities. If the main business of the investee companies is Halal, like automobiles, textiles, manufacturing concerns etc but they deposit their surplus amounts in an interest bearing account or borrow money on interest, the share holder must express his/her disapproval against such dealings, preferably by raising his/her voice against such activities in the annual general meeting of the company and/or by sending a letter to the management in this regard. 2. Screening Criteria # 2: Interest Bearing Debt to Total Assets, <37% The Interest Bearing Debt to Assets ratio should be less than 37%. To understand the rationale behind this condition, it should be kept in mind that such companies are mostly based on interest. Here again, the aforementioned principle applies i.e. if the shareholder is not personally agreeable to such borrowings, but has been overruled by the majority, these borrowing transactions cannot be attributed to him/her. Debt, in this case, is classified as any interest bearing debt including Bonds, TFCs, Commercial Paper, Conventional Bank Loans, Finance Lease, Hire Purchase, issuing preference shares etc. 3. Screening Criteria # 3: Non-Compliant Investments to Total Assets, <33% The ratio of Non Compliant Investments to Total Assets should be less than 33%. Non-Shariah Compliant Investments include investments in conventional mutual funds, conventional money market instruments, Commercial Paper, interest bearing bank deposits, Bonds, PIBs, FIB, T-Bills, CoIs, CoDs, TFCs, DSCs, NSS, derivatives etc. Non-Compliant investments also include investments in companies which are declared Shariah non-Compliant due to non-compliance to any of the mentioned criteria for Shariah Compliance.

4. Screening Criteria # 4: Non-complaint Income to Total revenue, <5% The ratio of Non Compliant Income to Total Revenue should be less than 5%. Total Revenue includes Gross Revenue plus any other income earned by the company. Non Compliant Income includes income from gambling, income from interest based transactions, income from Gharar based transactions i.e. derivatives, insurance claim reimbursement from a conventional insurance company, any penalty charged on late payment in credit sale, income from casinos, addictive drugs, alcohol, dividend income from above mentioned businesses or companies which have been declared Shariah Non-Compliant due to noncompliance to any of the mentioned criteria for Shariah Compliance etc. 5. Screening Criteria # 5: Illiquid Assets to Total Assets, >25% The ratio of Illiquid Assets to Total Assets should be at least 25%. The Sum of all those assets whose trade price can deviate from par value, according to the rules of Shariah, is considered the aggregate value of illiquid assets. Illiquid Assets include inventory of raw materials, work-in-process, all fixed assets such as property, plant & equipment, stores and spares, stock in trade etc. 6. Screening Criteria # 6: Net Liquid Assets/Share Vs Market Price/Share Market Price per share should be at least equal to or greater than net liquid assets per share. Net liquid assets per share are calculated by using the following formula: Net Liquid Assets Per share =

Total assets Illiquid assets long term liabilities current liabilities

No. of shares out standing

Technical Screening Filters

1. Screening Criteria # 1:

The Company which is on the Defaulters Counter and/or its trading is suspended, declared Non-Tradable (i.e. NT) in preceding 6 months from the date of re-composition shall NOT be considered for inclusion in KMI-30 Index; Islamic Index. 2. Screening Criteria # 2: The Company will be eligible for KMI-30 Index if its securities are available in the Central Depository System. 3. Screening Criteria # 3 The Company should have a formal listing history of at least two months on KSE Islamic Index.

4. Screening Criteria # 4 The company must have an operational track record of at least one financial year; 5. Screening Criteria # 5 The Company should have minimum free-float shares of 5% of total outstanding shares. 6. Screening Criteria # 6 The Company will be eligible for KMI-30 Index if its securities are traded for 75% of the total trading days 7. Screening Criteria # 7 Mutual Funds (both Open-Ended and Closed-Ended) are ineligible for inclusion in the KMI-30 Index.

KSE 100 INDEX

OBJECTIVE
The primary objective of the KSE100 index is to have a benchmark by which the stock price performance can be compared to over a period of time. In particular, the KSE 100 is designed to provide investors with a sense of how the Pakistan equity market is performing.

BRIEF ABOUT KSE-100 INDEX

The KSE-100 Index was introduced in November 1991 with base value of 1,000 points. The Index comprises of 100 companies selected on the basis of sector representation and highest market capitalization, which captures over 90% of the total market capitalization of the companies listed on the Exchange. Out of the following 33 Sectors, 32 companies are selected i.e. one company from each sector (excluding Open-End Mutual Fund Sector) on the basis of the largest market capitalization and the remaining 68 companies are selected on the basis of largest market capitalization in descending order. LIST OF SECTORS
1 2 3 4 5 6 7

Open-end Mutual Funds Oil and Gas Chemicals Forestry and Paper Industrial Metals and Mining Construction and Materials General Industries

19 20 21 22 23 24 25

Health Care Equipment and Services Pharma and Bio Tech Media Travel and Leisure Fixed Line Telecommunication Electricity Gas Water and Multiutilities

8 9 10 11 12 13 14 15 16 17 18

Electronic and Electrical Equipment Industrial Engineering Industrial Transportation Support Services Automobile and Parts Beverages Food Producers Household Goods Leisure Goods Personal Goods Tobacco

26 27 28 29 30 31 32 33

Banks Non Life Insurance Life Insurance Real Estate Investment and Services Financial Services Equity Investment Instruments Software and Computer Services Technology Hardware and Equipment

STOCK SELECTION RULES

The selection criteria for stock inclusion in the recomposed KSE100 Index are: Rule # 1 Largest market capitalization in each of the 32 Karachi Stock Exchange sectors excluding Open-end Mutual Fund Sector; Rule # 2 The remaining index places (in this case 68) are taken up by the largest market capitalization companies in descending order. Rule # 3 Company which is on the Defaulters Counter and/or its trading is suspended, declare Non-Tradable (i.e. NT) in preceding 6 months from the date of recomposition shall not be considered in the recomposition of KSE-100 Index.

Calculation methodology
The value of the basket is regularly compared to a starting point or a base period. In our case, the base period is 1st November, 1991. To make the computation simple, the total market value of the base period has been adjusted to 1000 points. Taking stock As share price of Rs. 20 and multiplying it by its total common shares outstanding of 500 in the base period provides a market value in Rupees. This calculation is repeated for stocks B and C with the resulting market values of three and six billion Rupees, respectively.

Calculating The Kse-100

Step 1
The Base Period Day 1
Stock Share Price (in Pak Rs.) 20 30 40 Total Market Capitalization Number of Shares 5000 1000 1500 Market Value (in Rs.) 10,000 30,000 60,000 100,000

A. B. C.

Note: Base Period Value/Base Divisor = Rs. 10,000,000,000.00 = 1000.00 Step 2 Index Value as on Day 2 Stock Share Price (in Rs.) 22 33 44 Total Market Capitalization Number of Shares 500 1000 1500 Market Value (in Rs.) 11,000 33,000 66,000 110,000 110,000 Index = = 1.10 * 1000 = 1100 100,000 Thus, the formula for calculating the KSE-100 Index is : Sum of Shares Outstanding x Current Price ________________________________________x 1000 Base Period Value

A. B. C.

RECOMPOSITION OF THE KSE-100 INDEX

Maintenance of the index over time will require an on-going semi-annual recomposition process. Index maintained by the Board of Directors/Management of the Exchange. Recomposition rules fall into two general categories: Sector Rules and Market Capitalization Rules.

1. Sector rules
Sector rules govern the selection (or deletion) of companies on the basis of being the top capitalization stock in each of the 32 KSE sectors (excluding Open-end Mutual Fund sector). Two rules are recommended to undertake selection in this area.

1.1 Time-based rule: A company (not in the index) which becomes the largest in its sector (by any amount of value) will enter the index after maintaining its position as largest in the sector for two consecutive recomposition periods. 1.2 Value-based rule: A company (not in the index) which becomes the largest in its sector by a minimum of 10% greater in capitalization value than the present largest in the sector (in the index) will enter the index after one recomposition period.

2. Capitalization Rule
Capitalization rules govern the selection (or deletion) of companies on the basis of being among the largest capitalization companies in the stock market. Only one rule applies here-time based rule. Rules for new issues A newly listed company or a privatized company shall qualify to be included in the existing index (after one recomposition period) if the market capitalization of the new or privatized company is at least 2% of the total market capitalization

Formula for New Divisor : Market Capitalization Index = x1000 Divisor Therefore, in order to get the new divisor than formula is reframed as: Revised Market Cap. New Divisor = x 1000 Index (Day 2) REPLACEMENT OF STOCK IN THE INDEX
The ABC index is calculated for day 2. However, it is assumed that stock D will replace stock B effective at the opening of trading on day 3. Therefore, the divisor adjustment is made, as shown, after the close of trading on day 2., stock Ds price, shares outstanding, and resulting market value are also as of the close of trading on day2.

Calculation
KSE-100 Index as on Day 2 KSE-100 Index Market Cap. of (A.B.&C) on Day 2 Divisor as on Day 2 = = = 1100 110,000 100,000

Step 1. Replace stock B with stock D after the close of trading on Day 2. Stock Share Price (in Rs.) 22.00 40.00 44.00 Number of Shares 500 1500 1500 Market Value (in Rs.) 11,000 60,000 66,000 137,000

A. D. C.

Revised Market Capitalization of Index

New Divisor = Revised Market Capitalization of Index x 1000 Index 137,000 = x 1000 = 124545.45 1100 The newly adjusted divisor is indeed larger, while the index values remain the same during this non-trading interval.
Application of new Divisor on Day 3. Stock Share Price (in Rs.) Number of Shares Market Value (in Rs.)

A B. C.

23 42 45

500 1500 1500

11,500 63,000 67,500

Total

142,000

Market Capitalization Index as on 3rd Day = x 1000 Divisor

142,000 = x 1000 = 1140 124545.45