How S&P 500 market index works (Part 1)

The S&P 500 index’s value is computed by using a free-float market capitalization weighted methodology. This involves measuring the performance of a group of stock as a single number. The methodology involves using the number of outstanding stocks of a company as a multiplier of the company’s current share price or market value.

For instance, let’s assume Bayo wants to compute an index for measuring the average movement in stocks of 5 companies traded on the New York stock exchange, he will compute the index by obtaining the number of outstanding shares for each company and the current market prices. Subsequently, he will compute the product of the variables obtained and sum them up. This will give the total market capitalization. This is illustrated below:

CompanyNo. of Outstanding sharesCurrent share priceMarket CapitalizationWeight
 abc=a*bd
Fictitious company A2,0003.26,40011.18%
Fictitious company B3,0003.510,50018.34%
Fictitious company C2,5003.17,75013.54%
Fictitious company D4,0003.212,80022.36%
Fictitious company E5,5003.619,80034.58%
  Σc57,250100.00%


Note: d= individual market capitalization/Σc

The individual weight will show how the individual stock will affect the market index.

The S&P 500 index is calculated as:
Index

Where Pi = Price of each stock in the index
          Qi = Number of shares used in the index

The numerator is the sum of the product of the price of stocks in the index and the quantity of stocks in the index, i.e the market capitalization.

When an equity weighting factor is integrated to the formula, it becomes;
Index Level
Where;
Pi = Price
IWFi = Equity weighting percentage
 
References:
Langager, C. (2019, June 29). How is the Value of the S&P 500 Calculated? Investopedia. https://www.investopedia.com/ask/answers/05/sp500calculation.asp#:%7E:text=The%20S%26P%20500%20Deconstructed&text=The%20S%26P%20500%20Index’s%20value,float%20market%20capitalization%20weighted%20methodology.&text=This%20calculation%20takes%20the%20number,share%20price%2C%20or%20market%20value.
S&P Dow Jones Indices. (2020, July). Index Mathematics Methodology. S&P Global.

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