4. Understanding Index-Weighting Choices

The S&P 500 Index was launched in 1957 and has grown to be the best known and most widely followed U.S. stock index in the world. Capitalization (cap) weighting is simple; it weights a company by the number of shares outstanding multiplied by the company’s market price. The effect of cap weighting is that the larger the company, the more effect it has on the index. Because a market cap is partly created by the price of the stock, the market is essentially valuing a company, which affects an index because of the weighting a company is given.

The cap-weighted method is more than 50 years old, and through the years, there have been critics of this method. Criticism includes that the market cap is related ...

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