If you have investments in any indexes (or, indices, if you prefer), time to listen up, because most indexes on the market today are capitalization weighted.
Capitalization weighted indexes are market indexes that have elements that are kept in proportion to their market capitalization. Let’s break that down.
You’ve heard of these: the S&P 500, the Nasdaq Composite. These indexes are weighted, meaning all the goodies inside them aren’t equally represented. Which is good, right? If Apple, Google, and Microsoft make up a large part of a tech-index, then you’d want to be more invested in them than equally invested in some tiny tech start-up that...might not make it.
Finding the value of a cap-weighted index is pretty straightforward. Just take the total shares x the price per share to get the market value, then compare market values.
For instance, if there was a two-stock index (hopefully not in real life) with company A having 100 stocks at $1 each and company B having 50 stocks at $5 each, that would mean A has a market value of $100 and B of $250. These companies will be proportionally represented in the index, so you’ll be more invested in B than A by 2.5x.
Makes sense...so why is this so important to know? Well, it means that, if there’s volatility among the big boys, the index you’re invested in will feel more like you put all your eggs in one basket rather than many. And if you’re invested in an index, it’s probably because you wanted some variety in your life, for risk’s sake. It also means that, if one company grows super fast, they may be suddenly taking up a huge amount of an index by weight, distorting the market...and maybe your investments in a sense, too.
The lesson: your index might not always be as varied and safe as you think it is. So wear protective gear and brace for impact.
Related or Semi-related Video
Finance: What is recapitalization?34 Views
finance a la shmoop what is recapitalisation all right people think
nee capitalization you know in Jersey like when you owe the mob money at least [thug breaks knee with bat]
that's what it feels like if you're a common equity stockholder of a company [businessman with common stock]
that has been recapped well usually recapitalisation is a very kindly loving
politically correct term for a pal you're bankrupt you borrowed money you
promised to pay back and you didn't so now you're out and the lenders now own
your company buh and buy so typical recap comes from a company that was very
early stage and had preferred stock upon preferred stock from venture capital
investors sitting above their common in the priority stack and eventually the
company burned through eighty seven million dollars and it has just a [dollars on fire]
million bucks left in the bank and it built something out of that eighty seven [company logo graveyard]
million not quite worth putting here yeah but it might be worthy of a new
investment of say yo thirty million or more dollars but the marketplace values [money going into company briefcase]
this zombie company yes that's what they're called at a [zombie briefcase walking at night]
value well less than the eighty seven million that has been raised previously
so everything is marked down usually with a common in total being worth [store during closing sale]
something like one percent of the new company and that's oh so sad for the
founders because it was a hundred percent of the company the day they
started so they were recapped and lest more mature companies feel left out well
recapitalisation happens in later stage companies as well and the radio industry
famously took on too much debt in the late 1990s and then people stop [radio knob getting changed]
listening to Drivetime radio as cell phones and satellite radio intruded I
bring radio borrowed five billion dollars at seven percent to oh three
hundred fifty million a year and then when cash earnings fell well below that
number while the company had to recap its five billion of debt such that those
debt holders now own essentially all of I brain radio and hope to someday milk
enough cash out of it to get their principal back knowing and it'll likely [goat getting milked]
be a very low interest rate or a low return on their and
if a positive one at all hopefully that all made sense you the first time though
because well we don't have time here in this video for a recap
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