The total value is $440.Divide the value of all the stocks by the number of stocks in the index to find the value of the index. The capitalization-weighted index uses a stock's market capitalization to determine how much impact that particular security can have on the overall index results. Copyright 2020 Leaf Group Ltd. / Leaf Group Media, All Rights Reserved. Market-cap indexes provide investors with access to a wide a variety of companies both large and smallLarge well-established companies have a greater weighting providing steady growth for the indexSmall companies tend to have a lower weighting, which can reduce risk if the companies don't surviveAs a stock price rises, a company can have an excessive amount of the weighting in an indexCompanies with larger weightings can have a disproportionate impact on the fund's performanceFund managers can often add shares of overvalued stocks assigning a larger weighting and create a bubble This systematic flaw appears to cost market cap-weighted indexes approximately 2% per year in return over long periods.

The S&P is a market-cap weighted index containing some of the most well-established companies in the U.S. However, since large companies with numerous outstanding shares tend to be more stable revenue producers, they can provide steady growth for the index. Critics of the cap-weighted indices might argue that the overweighting toward the larger companies give a distorted view of the market. The FTSE RAFI US 1000 Index is an index of stocks based on the largest 1,000 fundamentally ranked companies. On the other hand, small companies tend to have a lower weighting, which can reduce risk if the companies don't perform well. To calculate the value of a value-weighted index, sum the market capitalization for each company and divide it by a divisor which is set initially to make the index a round number. It's important to note that the market cap weightings change daily with the companies' outstanding shares and their prices, which results in varying impacts on the overall Dow's value. Finishing the example, multiply 0.1 by 100 to find the rate of return on the price-weighted index is 10 percent. Capped index is an equity index that has a limit on the weight of any single security. Loading... Unsubscribe from Kim Gaither? Finishing the example, multiply 0.1 by 100 to find the rate of return on the price-weighted index is 10 percent.Calculate Abnormal Returns with Stock Prices and S&P InformationCalculate the Average Return on a Portfolio of StocksMark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool." In this example, divide $440 by 4 to find the index value is $110.Subtract the starting index value from the ending index value to figure the numerical gain or loss on the investment. To find the value of a cap-weighted index, we can multiply each component's market price by its total outstanding shares to arrive at the total market value. Over time, companies can grow to the extent that they make up an excessive amount of the weighting in an index. Advantages. Continuing the example, divide $10 by $100 to get a return rate of 0.1. Say the index has four stocks that sell for $40, $70, $140 and $150. For example, if you want to figure the rate of return for a given year, add the opening stock prices of each company on Jan. 1. The proportion of the stock's value to the overall total market value of the index components provides the weighting of the company in the index. As a result, purchasing stocks based on market-cap weightings can lead to a stock market bubble and increase the risk of the bubble bursting sending stock prices into free fall. If you only wanted to calculate the period rate of return, subtract 1 from this figure to get 0.01856, or 1.856 percent. For example, consider the following five companies: The S&P 500 Index or the Standard & Poor's 500 Index is a market-capitalization-weighted index of the 500 largest U.S. publicly traded companies.

Next, subtract the starting price from the ending price to determine the index's change during the time period.

Although companies D and E have equal amounts of shares outstanding at 1,500,000, they represent the highest and lowest weightings in the index, respectively, because of the effects of their prices on their individual market values.

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