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Capitalization-Weighted Index

A stock market index wherein each component is weighted relative to its total market capitalization

What is the Capitalization-Weighted Index?

The Capitalization-Weighted Index (cap-weighted index, CWI) is a type of stock market index in which each component of the index is weighted relative to its total market capitalization. In the capitalization-weighted index, companies with larger market capitalization exert a greater impact on the index value, while companies with a smaller market capitalization carry less significance.

 

Capitalization-Weighted Index

 

The capitalization-weighted index is currently the most common stock market index. The largest and most prominent market indices – including S&P 500, the NASDAQ Composite, and the FTSE 100 – are capitalization-weighted indices.

 

Breaking Down the Capitalization-Weighted Index

The capitalization-weighted indices are widely used because the values change proportionally to the price changes of each component (since market capitalization is determined by the stock price multiplied by the number of shares outstanding). The indices also consider the shareholder base of each component.

Since some companies own shares that are not fully available to the public, most of the indices use a free float factor to adjust calculations. A free float factor is the percentage of the shares available for trading.

However, some investors criticize capitalization-weighted indices for providing a distorted view of the stock markets. Many believe that the primary reason for the distortion is the overweighting toward companies with the largest market capitalization.

 

How to Calculate Weights in a Capitalization-Weighted Index?

The CWI Composite is a capitalization-weighted index. It consists of four companies only: Company A, Company B, Company C, and Company D. The summary of the current stock prices and the total number of the shares outstanding for each company is given in the table below:

 

Capitalization-Weighted Index

 

Using the information from the table above, we can calculate the market capitalization of each index component. The market capitalization can be found through the following formula:

Market Capitalization = Stock Price x No. of Shares Outstanding

 

Thus, the market capitalization of each company in the index is:

  • Company A = $5 x 5,000,000 = $25,000,000
  • Company B = $10 x 1,000,000 = $10,000,000
  • Company C = $25 x 500,000 = $12,500,000
  • Company D = $15 x 1,500,000 = $22,500,000

 

The total market capitalization of the index is the sum of the market capitalization of all the components. Therefore, the market capitalization of the CWI Composite is:

CWI Composite = $25,000,000 + $10,000,000 + $12,500,000 + $22,500,000 = $70,000,000

 

The weight of each index component is determined using the formula below:

 

Capitalization-Weighted Index - Formula

Sample Calculation

 

Related Readings

CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful:

  • Common Stock
  • Diluted Shares Outstanding
  • Nikkei Index
  • Weighted Average Shares Outstanding

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