# understanding interest rates and stock indices

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### understanding interest rates and stock indices:

understanding interest rates and stock indices narendra

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The interest rates can be discrete or continuous . When people invest in financial markets (such as equity shares), returns on assets change continuously and lead to the fact that continuous compounding should be used . The interest rates are always quoted on per annum basis. However, they also indicate the frequency along with the per annum rates .

### Interest rate and Compounding Frequency:

I nterest rate and Compounding Frequency Principal ( rs ) interest rate (%) Compounding Frequency Calculation amount in one year ( rs ) 100 10 Annual 100(1+10%) 110 100 10 Semi annual 100(1+10%/2)2 110.250 100 10 Quarterly 100(1+10%/4)4 110.381 100 10 Monthly 100(1+10%/12)12 110.471 100 10 Daily 100(1+10%/365)365 110.516 100 10 continuous 100 * e (10% * 1) 110.517

### understanding the stock index:

understanding the stock index An index is a number which measures the change in a set of values over a period of time. A stock index represents the change in value of a set of stocks which constitute the index. The beginning value or base of the index is usually set to a number such as 100 or 1000. For example, the base value of the Nifty was set to 1000 on the start date of November 3, 1995 . Stock market indices are useful for a variety of reasons. Some uses of them are: 1. As a barometer for market behaviour, 2. As a benchmark for portfolio performance, 3. As an underlying in derivative instruments like Index futures, Index options, and 4. In passive fund management by index funds/ETFs.

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Every stock price moves for two possible reasons : News about the company- micro economic factors. News about the economy – macro economic factors. A good index is a trade-off between diversification and liquidity. well diversified index is more representative of the market/economy. There are however, diminishing returns to diversification. The computational methodology followed for construction of stock market indices are ( a) Free Float Market Capitalization Weighted Index, (b) Market Capitalization Weighted index and the (c) Price Weighted Index.

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The India Index Services Limited (IISL), a joint venture between the NSE and CRISIL, introduced the free float market capitalization methodology. A good market index should have three attributes: Itshouldcapturethebehaviourofalargevarietyofdifferentportfoliosinthemarke The stocks included in the index should be highlyl iquid . It should be professionally maintained. The CNX Nifty covers 21 sectors of the Indian economy and offers investment managers exposure to the Indian market in one efficient portfolio. It is used for a variety of purposes, such as benchmarking fund portfolios, index based derivatives and index funds . For a stock to qualify for possible inclusion into the CNX Nifty, it has to have market impact cost of below 0.50 % when doing CNX Nifty trades of two crore rupees.

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Besides serving as a barometer of the economy/market, the index also has other applications in finance. Various products have been designed based on the indices such as the index derivatives , index funds and the exchange traded funds . We here restrict our discussion to only index derivatives.