Capitalization Weighted Index

It is an index in which weightage of a stock is established by its total market capital. Any change in the price of the share will bring a change in its weighted contribution to the index as well. It is also called Market value-weighted Index
Market capital or capitalisation = No of outstanding shares x Current price
Thus, larger the market cap, the larger is its weight on the index.

Features of Capitalization Weighted Index

Features of Capitalization Weighted Index are:
1. Companies with higher market caps will have higher weightage in the index.
2. Small or Mid caps will have lesser impact.
3. Most of the big indexes use the Capital Weighted Index mechanism.

Advantages of Capitalization Weighted Index

Advantages of Capitalization Weighted Index are:
1. Well established blue chip stocks have a greater weightage and these promote stability and lower volatility on Index.
2. It gives a stock’s relative value.

Disadvantages of Capitalization Weighted Index

Disadvantages of Capitalization Weighted Index are:
a) A huge rise in price can have an outsized impact on the index.
b) Investors buying Index based Mutual Funds or Exchange Traded Funds (ETFs) will have disproportionate exposure to some stocks.