STOCK PRICE INDEX

1. STOCK PRICE INDEX

2. S&P CNX Nifty • Comprises of 50 stocks • Selection Criteria • Market Capitalization • Liquidity: Each should have traded at least 85% of the trading days at an impact cost of < 1.5% • Impact Cost: %age mark up suffered while buying/ selling the desired quantity of shares, as compared to the ideal price (Avg. of Bid & Ask Price)

3. Impact CostExample: Order Book of a broker Calculate Impact Cost for buying 1500 shares Ideal Price = (98+99) / 2 = Rs. 98.50 Actual Buy price = (1000 x 99 + 500 x 100) / 1500 = Rs. 99.33 Impact Cost = {(99.33 – 98.50) / 98.5} = 0.84% If the impact cost is consistently > 1% then the stock moves out of the index. This is another indicator of liquidity.

4. Company Weightage in Index • Shares bear a weight in the index in proportion of their M. Cap. • Example: Base Period Index = 1.000X 1000 = 1000 • Suppose current M Cap = Rs. 880000 (due to market price changes) • Current Index = (Current Cap / Base Cap) x 1000 = 1.073 x 1000 =1073

5. Index Maintenance • Index should remain constant It = (Mt /M0) x I0 M0 = Mt x ( I0/ It ) It - Index Today; I0- Base Index M0 - Base year M Cap; Mt - M Cap today ∆M0 = ∆Mt x ( I0/ It ) M’0 (New Base Cap) = M0+ ∆M0 = M0 + ∆Mt x ( I0/ It )

6. Index Maintenance (Contd…) • Example: On 5 April: M0 = Rs. 195000 crores Mt = Rs. 197500 crores It = (Mt / M0) x I0 = (197500 / 195000) x 1000 = 1012.82 Scrip A with a Cap of Rs. 1000 crores, gets replaced with Scrip B with a Cap of Rs 900 crores M’0 (New Base Cap) = M0 + ∆Mt x ( I0/ It ) =195000 + (900 – 1000) x (1000/1012.82) = 194901 crores Mt = 197500 – 100 = 197400 crores It = (197400 / 194901) x 1000 = 1012.82

7. Efficient Market Hypothesis • EMH • Security prices incorporate all past/new information in a rapid and unbiased manner • Investors will not b able to systematically outperform the market by following conventional approaches (use of charts/trends or in search for mispriced securities) • Refers to only informational efficiency

8. EMH (Weak Form) • Three forms of EMH • Weak Form: Security prices fully reflect the information implied by all prior price movements – successive price movements are independent • AKA Random Walk Hypothesis • Common testable form of RWH • lnPt = lnPt-1 + έ • Where E (έ) = 0 & Cov (έt, έt-1) = 0 • Or ln(Pt /Pt-1) = έt • The model considers only the linear independence – meaning thereby that investors immediately react to new information – investors do not react react in a cumulative fashion to a series of events. • Stock process follows a Brownian Motion

9. EMH (Contd…) • Traditional Tests of RWH • Serial Correlation Test • Runs test • Evidence against EMH – Market Anomalies • Day-of-the-week effect • January effect • P/E effect • Small-firm effect • Reversal effect – losers rebound and winners fade away

10. EMH (Contd…) • Biased Random Walk of stock prices • Stock returns found to be skewed and leptokurtotic (fat tails & high peaks) • Information shows up in infrequent lumps, which explains non-normal distribution of price movements • Several studies found volatility of stock returns to be unstable overtime • High volatility followed by even higher volatility; while low volatility is followed more lower volatility.

11. EMH (Contd…) • Most investors react to information in a non-linear way – wait for confirming information and do not react until a trend is established • Influence of past – a clear violation of EMH

12. EMH (Other Forms) • Semi Strong Form: Security prices reflect fully all publicly available information – not possible to consistently outperform the market from any analysis of published data • Strong Form: Security prices not only reflect fully the published information but also privileged information – even insiders cannot consistently outperform the market