Custom Index Creation

We will continue with our example of banking sector stocks which we covered in last two articles. Let’s say we decide to go with the equi-weight scheme, then following would be our initial portfolio, as calculated in the first article on weighting schemes.

Suppose we make the above investment today and call it Day 0. At the end of Day 0, we will buy the above mentioned number of shares of each stock to build our portfolio. Next day (Day 1), no of shares will remain constant but the price of each stock will change. Value of each stock will be its market price multipl  ied by the no of shares. Total portfolio value will be the sum of individual stock values. Weight of a particular stock will be calculated by dividing its current value by the total portfolio value. Look at the table below, to understand how everything will be calculated on Day 1 when stock prices change

From the above table, it’s clear how weights and value of each stock changes on a daily basis. No of shares always remain constant, as we are not placing any new buy/sell trade on the exchange. Everything is calculated based on the existing no of shares and current market prices. The best way to track a portfolio and calculate its return is through creation of custom index. The initial amount on Day 0 is INR 50056.15. We can rebase this value to 100 and then calculate all future vales on this scale. Basic unitary mathematics say that if 50056.15 = 100, then 1 unit is equal to 100/50056.15. As calculated in the above example, the value next day is 52108.65. If 1 = 100/50056.15, then 52108.65 = [52108.65 * (100/50056.15)] = 104.1. Following table shows how custom index values will be calculated, assuming column B represents value of your portfolio on future dates.

Let’s now understand the usefulness of custom index values in calculating portfolio returns & risks.