Vasanth
Oct 10th, 2015
Types of Indices
In the previous article we learnt how to create, track and understand an index. This article will discuss various types of indices one can create using different weighting methodologies. There are 3 different weighting schemes that we can use:
1. Price Weighted : stocks in the index are weighted based on their prices, stock with the highest price will have the highest weight
2. Market Cap Weighted : stocks in the index are weighted based on their market capitalization, stock with highest market cap has the highest weight
3. Equal Weighted : stocks in the index are equally weighted
Suppose you decide to invest Rs 5000 in 5 stocks – AA, BB, CC, DD, EE.
Initially at the time of investing on Day 1, price and market cap of stocks AA,BB,CC,DD and EE are Rs 10, 20, 30, 40 & 50 and Rs 2000, 3000, 15000, 10000, 5000 respectively. Let’s assume at the end of day 2, prices of stocks BB and EE have increased by 50%, while prices of all other stocks remain constant. The tables below explain how value of your investment will change each day depending on the weighing scheme.
1. Price Weighted
Day 1
| Stock (A) | Price (B) | No. of Shares (C) | Weight (D=B/150) | Value of Investment (E=D*5000) |
|---|---|---|---|---|
| AA | 10 | 1 | 6.7% | 333.3 |
| BB | 20 | 1 | 13.3% | 666.7 |
| CC | 30 | 1 | 20% | 1000.0 |
| DD | 40 | 1 | 26.7% | 1333.3 |
| EE | 50 | 1 | 33.3% | 1666.7 |
| Total | 150 | 100% | 5000.0 |
Day 2
| Stock (A) | Price (B') | No. of Shares (C) | New Weight (D=B/185) | Value of Investment (E'=E*B'/B) |
|---|---|---|---|---|
| AA | 10 | 1 | 5.4% | 333.3 |
| BB | 30 | 1 | 16.2% | 1000.0 |
| CC | 30 | 1 | 16.2% | 1000.0 |
| DD | 40 | 1 | 21.7% | 1333.3 |
| EE | 75 | 1 | 40.5% | 2500.0 |
| Total | 185 | 100% | 6166.7 |
2. Market Cap Weighted
Day 1
| Stock (A) | Price (B) | Market Cap (INR) (C) | No. of Shares (D=F/B) | Weight (E=C/35000) | Value of Investment (F=E*5000) |
|---|---|---|---|---|---|
| AA | 10 | 2000 | 28.57 | 5.7% | 285.7 |
| BB | 20 | 3000 | 21.43 | 8.6% | 428.6 |
| CC | 30 | 15000 | 71.43 | 42.9% | 2142.9 |
| DD | 40 | 10000 | 35.71 | 28.6% | 1428.6 |
| EE | 50 | 5000 | 14.29 | 14.3% | 714.3 |
| Total | 35000 | 100% | 5000.0 |
Day 2
| Stock (A) | Price (B) | No. of Shares (C) | New Weight (D=E/5571.43) | Value of Investment (E=B*C) |
|---|---|---|---|---|
| AA | 10 | 28.57 | 5.1% | 285.71 |
| BB | 30 | 21.43 | 11.5% | 642.86 |
| CC | 30 | 71.43 | 38.5% | 2142.86 |
| DD | 40 | 35.71 | 25.6% | 1428.57 |
| EE | 75 | 14.29 | 19.2% | 1071.43 |
| Total | 100% | 5571.43 |
3. Equal Weighted
Day 1
| Stock (A) | Price (B) | No. of Shares (C=E/B) | Weight (D) | Value of Investment (E=D*5000) |
|---|---|---|---|---|
| AA | 10 | 100.0 | 20% | 1000.0 |
| BB | 20 | 50.0 | 20% | 1000.0 |
| CC | 30 | 33.3 | 20% | 1000.0 |
| DD | 40 | 25.0 | 20% | 1000.0 |
| EE | 50 | 20.0 | 20% | 1000.0 |
| Total | 150 | 100% | 5000.0 |
Day 2
| Stock (A) | Price (B) | No. of Shares (C) | New Weight (D=E/6000) | Value of Investment (E=B*C) |
|---|---|---|---|---|
| AA | 10 | 100.0 | 16.7% | 1000.0 |
| BB | 30 | 50.0 | 25.0% | 1500.0 |
| CC | 30 | 33.3 | 16.7% | 1000.0 |
| DD | 40 | 25.0 | 16.7% | 1000.0 |
| EE | 75 | 20.0 | 25.0% | 1500.0 |
| Total | 185 | 100% | 6000.0 |
At end of day 2 it be can see that the value of your investment is different, in each one of the above weighting scheme. In our example, price weighted methodology generated maximum return. However the outcome would have been completely different had the stock price fluctuated in some other manner.
At smallcase, you can easily pick the desired weighting scheme or use the one recommended by our platform. Picking the right weighting scheme is very important, as it can significantly impact your returns.
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