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How A Stock's Inclusion and Exclusion In An Index Is Decided?
On a semi-annual basis, constituents of each of the stock index are reviewed and basis important paraneter, exclusion or inclusion decision for a stock is taken to bring about a shift.
Ever wondered why few stocks are included or excluded from an Index and what forms the basis which determines the decision of exclusion and inclusion. The Index i.e. constituted by a set of stocks reflects the movement in prices of a particular industry or a combined market as a whole. And, in every six months time the index and its constituents are reviewed which leads to a change.
Know few of the important factors or parameters determining exclusion and inclusion of a stock, herein
1. Market Capitalisation: The multiple of no. of outstanding shares by the company and its price in the market equals its market capitalization. For a stock to be included in either the BSE Sensex or CNX Nifty, it has to maintain an average of Rs. 500 crore or more in the last six months time. And in the sectoral index they are given weights in accordance with its market cap.
2. Investable Weight Factor: For an easy understanding, shares of the company should have easy access for day to day trading and should be locked with the promoters of the company.
IWF= No. of Outstanding Shares-No. of shares held by parties with strategies interest in the stock/ No of outstanding shares.
For an inclusion decision, a minimum IWF of 10% is mandatory. Also note, any shares held by promoters etc. is not taken while computing market cap for a stock.
3. Market Impact Cost: To ensure there is no sudden increase or decrease in price of a stock, a market impact cost of less than 0.5% on an average basis during the last six months is desirable.
Calculation of Market impact cost: Decided on the basis of the % mark-up or down when a select number of stocks are bought or sold at the best bid or ask price. Fixed cost is not taken into account while computing Market Impact Costs.
4. Trading History on each trading day for the last three months is maintained. Nonetheless, exception is considered in some cases.
5. Listing: To qualify for inclusion in an index, a minimum of 6 months listing history is needed. For a new stock, inclusion is done basis its compliance with the above listed factors.
For determining exclusion from an Index : Every six months new eligible stocks are compared against the already existing stocks in an index. Smaller stocks are likewise excluded. Corporate strategic events such as a merger or acquisition, spin-off etc may also bring about the decision.
Impact of Inclusion and Exclusion on the Stock Price
Deemed as a temporary and a regular phenomena, inclusion of a stock or its exclusion from an index reflects the change in valuation of a company with no change in underlying fundamentals. However, no permanent change in the stock price is ruled and hence trader and investor cannot make any huge gains on inclusion or exclusion of a stock from the sectoral or stock market index.
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