On yesterday's news on NBR it was stated that the S&P 500 will remove several stock listings and add substitutes to replace them. My question is how is the index calibrated to account for these changes? The to be replaced companies have been in the dumper so to speak and the replacements are relatively more sound and level priced stocks. How do the managers of this index account for the transition? (July 10, 2002)
The S&P 500 is market cap weighted. That means those stocks with the largest capitalization have the most impact on the index movements. If you take out a stock whose market capitalization has tanked and replace it with a stock with a larger market cap, the value of the index will rise. What fund managers must do is factor in the market cap of the stocks coming in and those going out and determine what the overall value of the index is and what percentage the new stocks make up of that value. Then the new stocks are bought and positions of stocks already in the index are bought or sold to get the fund inline with the overall index.
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