Indices: Free-Float Construction and Maintenance
The Indices domain tests how benchmarks such as the Nifty 50 are built, maintained and used. Dealers need this because index derivatives, portfolio benchmarks and passive flows all depend on methodology, and many questions are simple free-float arithmetic.
Free-float methodology
- Only shares available for public trading enter the calculation: promoter holdings, strategic stakes, government holdings in some cases and locked-in shares are excluded.
- Index value = (Σ free-float market capitalisation ÷ divisor) × base value.
- The divisor is adjusted for corporate actions (splits, bonuses, rights) and constituent changes, so index continuity is preserved.
Eligibility and maintenance
- Candidates are screened on free-float size, liquidity (impact cost of a standard trade), trading frequency and, for sector indices, industry classification.
- Reviews are periodic and replacements are announced in advance of implementation.
- Weight caps stop one stock dominating: the Nifty 50 applies a 10% single-stock weight cap.
Worked example. A two-stock index has a base value of 1,000 and a base-period free-float market cap of ₹5,000 crore, so the divisor is 5. Today stock A has total market cap ₹10,000 crore with 40% free float (₹4,000 crore) and stock B ₹6,000 crore with 50% free float (₹3,000 crore). Total free float = ₹7,000 crore. Index = (7,000 ÷ 5) × 1,000 = 1,400.
Traps. Using total market cap instead of free-float cap is the classic error. So is treating a divisor change as a market event - it is designed to be neutral. Impact cost is not the same as the bid-ask spread; it measures the price movement needed to execute a specified order size. Finally, a stock's weight in a capped index is not its raw free-float share.