Today our lesson will be based on Market Indices & Market Capitalisation of a Company.
A Market index is a benchmark of the value of a range or market of shares. An index allows you to see what the overall performance of the market is and allows comparing of an individual shares performance against the general trend of the market. Shares in different sectors, and you can compare different sectors.
A benchmark is a standard against which something can be measured or assessed.
Example: FTSE100, (UK) or the Dow Jones (USA).
1. On-going market valuation of a public firm (whose shares are publicly traded) computed by multiplying the number of outstanding shares (held by the shareholders) with the current per share market price. It is, however, not necessarily the price a buyer would pay for the entire firm. And is not a realistic estimate of the firm’s actual size, because a share’s market price is based on trading in only a fraction of the firm’s total outstanding shares.
To explain this, let’s assume an index constitutes of 3 Companies. Obviously, that will never be the case. FTSE 100, IS MADE UP OF 100 Companies, S&P 500, constitutes of 500 Companies, but to illustrate we will be using 3 Companies.
COMPANY PRICE SHARES MARKET CAP S.PRICE MARKET CAP
A £1 2000 £2000 £4 £8000
B £ 4 1000 £4000 £6 £6000
C £ 6 700 £ 4200 £ 4 £ 2800
Total £ 11 £ 10200 £14 £ 16800
Therefore to find the index, we have to get the performances of these 3 companies in one number. Remember an index is to show performance over time.
We have Company A, B & C.
Company A at traded £1, with, outstanding shares of 200
Company B traded at £4, with outstanding shares of 1000.
Company C traded £6, with outstanding shares of 700
The Market Cap (Market Capitalization) for any Company is Price * Outstanding Shares. Therefore yesterday Company A’s Market Cap was £2000 and Company B was £4000.
Since there is a great possibility that the stock price of any particular Company will change on a daily basis, therefore we should expect the Market Cap also to change.
In the above example, we see that the prices of all the 3 companies changed today as compared to the prices of yesterday. Therefore the Market cap for each company will change and this will ultimately, affects the index.
As we mentioned earlier to find the index is to get the performance of all the companies into one number, in our simplified above it would be, today’s close of Market Cap * divided by yesterday’s close of total Market Cap.
So we have 16800/ 10200= 1.647
To find the index using Market Cap, we therefore say, we are using VALUE.
We could also find the index using PRICE. That would be adding all the prices of the companies in the index for today (close) and divide the figure by the total price of yesterday.
In our example, it would be 14 divided by 11(14/11) =1.2727
The FTSE 100, Uses Market capitalization. – VALUE
The Dow Jones uses PRICE to calculate the index
So basically, different indexes around the world will either be using Value (Market Cap) to calculate its index or price.
Until next time – Keep Believing, Keep Hoping & Keep Loving