Index

An index is a way of answering "how did the market do today?" with one number.

In financial markets, the workbook defines an index as a portfolio of securities that represents a particular market or a portion of a market. Every index has its own calculation method, and every index is expressed as a change from a base value. The base value could be as recent as yesterday or many years in the past — which is why the workbook says the percentage change is more important than the actual numeric value. A Nifty at 25,000 tells you nothing by itself; a Nifty that rose 1.2% today tells you something.

A stock index does three jobs:

• It is an indicator of performance of the overall market or a sector.
• It is a benchmark against which managed portfolios — individual or mutual fund — are judged.
• It is an underlying for derivatives. Index futures and index options, in the OTC and exchange-traded markets, are built on it.

The workbook splits index management into three activities, done by specialised agencies — Asia Index Pvt Ltd for BSE indices and NSE Indices Limited for NSE indices:

Maintenance is triggered by a corporate action; revision is a continuous exercise. The final decision on including or removing a stock is generally taken by an Index Committee.

Construction is a trade-off between diversification and liquidity. Going from 10 to 20 stocks cuts risk sharply; going from 50 to 100 cuts it very little; going beyond 100 causes almost zero further decline.

A good index, the workbook says, should reflect market behaviour, be computed by an independent third party free of any participant's influence, and be professionally maintained.

For derivatives on an index, two sets of numbers apply. An exchange may introduce index derivatives if constituents individually eligible for derivatives make up at least 80% of the index weight, with no single ineligible stock above 5%. And under the SEBI circular of 30 October 2025, derivatives on existing non-benchmark indices need a minimum of 14 constituents, a top constituent weight of 20% or less, top three combined at 45% or less, and a descending weight structure.

Market-capitalisation weighted index = (Current market cap / Base-date market cap) × Base value

The workbook's five-stock index, base value 100 on 1 January 1995 (shares in lakhs, prices in rupees):

Index now = (42,500 / 18,800) × 100 = 226.06
Change     = 226.06 − 100 = 126.06%

Notice what drove it. DW's price rose 3.5 times and its weight climbed from 0.16 to 0.25; BY rose only 50% and its weight fell from 0.19 to 0.13. In a market-cap weighted index, the winners take over the index. The same five stocks give a very different answer under a price-weighted or equal-weighted method.

Chapter 2 (Understanding the Index) is short and almost entirely examinable: the definition, the three uses, the three weighting methods with their worked tables, the attributes of a good index, and the construction / maintenance / revision distinction. Chapter 6, section 6.3, adds the 80% and 5% eligibility criteria for index derivatives and the Product Success Framework; section 2.5 carries the non-benchmark index norms.

• Maintenance versus revision. A bonus issue triggers maintenance. Replacing a stock that has become illiquid is revision. Questions swap the two.
• The numeric level is not the story. The workbook states plainly that percentage change matters more than the value.
• Diversification beyond 100 stocks adds almost nothing. An option saying "more stocks always means much lower risk" is wrong.
• 80% and 5% are the index-derivative eligibility numbers; 14, 20% and 45% are the non-benchmark index norms. Keep the two sets apart.
• Sensex and Nifty were earlier market-cap weighted; they have moved to free float. An answer describing them as full market-cap weighted today is stale.