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NISM Certifications · NISM-Series-VIII: Equity Derivatives · Understanding Index

An index with a free-float market capitalisation of Rs 5,00,000 crore and a divisor-equivalent value of 20,000 undergoes a constituent replacement. The outgoing stock has a market capitalisation of Rs 10,000 crore and the incoming stock Rs 15,000 crore. Which approach keeps the index value unchanged at the time of replacement?

The base capitalisation or divisor is adjusted so that the index value stays the same right after the constituent replacement. Without this adjustment, the higher capitalisation of the incoming stock would artificially raise the index, though no market movement occurred.

  1. ALeave the divisor unchanged so the index rises
  2. BAdjust the divisor (base capitalisation) so the index value is the same immediately after the changeCorrect
  3. CReduce the incoming stock weight to 10,000 crore only
  4. DReset the index value to the base value

Explanation

Index maintenance adjusts the divisor or base market capitalisation so that a constituent change does not alter the index level. New market cap is Rs 5,05,000 crore, so the base capitalisation is scaled up by 5,05,000/5,00,000 to keep the index at the same level. Leaving it unchanged would artificially lift the index.

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