WEBVTT 00:00.620 --> 00:06.440 In this in the next videos we'll finally learn how to construct a value weighted also called market 00:06.440 --> 00:08.140 cap weighted index. 00:08.270 --> 00:14.540 And from a theoretical point of view the evaluated index is the most meaningful index as it reflects 00:14.540 --> 00:21.650 how the aggregate market and the average investor is invested in the market because the constituents 00:21.680 --> 00:28.490 are weighted in proportion to their market capitalization so the market capitalization is nothing else 00:28.550 --> 00:31.410 than the company's total equity value. 00:31.550 --> 00:40.530 And we can calculate the market capitalization by multiplying the stock price with the shares outstanding. 00:40.580 --> 00:46.950 So let's assume BFA stock with a stock price of 100 and we have a total of 10 shares for that stock. 00:47.030 --> 00:52.920 So the total market capitalization is one hundred times ten is 1000. 00:53.120 --> 00:57.740 So the total equity value of that company is 1000. 00:57.770 --> 01:03.260 And that's actually a difference between total shares and free float. 01:03.260 --> 01:09.800 So typically some shares are privately held by founders and executives and they're actually not available 01:09.800 --> 01:12.440 for the public and a free float. 01:12.440 --> 01:20.000 Market capitalization weighted index only takes into account the number of public available shares but 01:20.000 --> 01:22.250 that's actually beyond the scope of this cost. 01:22.310 --> 01:25.120 And this is all you need to know here. 01:25.340 --> 01:29.450 And let's go to an easy example with some numbers. 01:29.570 --> 01:34.880 So still we have our prices for stock A and B and. 01:34.970 --> 01:37.700 We also have the number of shares. 01:37.700 --> 01:46.040 So on timestamp 0 and timestamp 1 we have a 10 shares for stock A and B for shares of stock B in the 01:46.040 --> 01:46.910 market. 01:47.270 --> 01:51.110 And having the prices and the number of shares outstanding. 01:51.230 --> 01:58.700 Then we can calculate for each and every time stamp the market capitalization so the market capitalization 01:58.700 --> 02:05.700 for stock a at the timestamp 0 is simply five times ten so five times ten. 02:05.870 --> 02:13.400 And the market cap for stock a in timestamp 1 is consequently eighty so eight times ten and the same 02:13.400 --> 02:15.350 we can calculate for stock P. 02:15.740 --> 02:18.950 So these are the market capitalizations for stock beer. 02:19.010 --> 02:22.140 And then finally we can take the sum for stock and stock B. 02:22.580 --> 02:26.790 So the total market cap for those two stocks is 90. 02:26.780 --> 02:35.170 In timestamp 0 and the 112 timestamp 1 and now we can create our value weighted index. 02:35.180 --> 02:43.400 So as always that the base value at the time stamp 0 is 100 and the value at timestamp 1 we can simply 02:43.400 --> 02:49.310 calculate by multiplying 100 times the one hundred twelve divided by ninety two gifts of one hundred 02:49.310 --> 02:51.900 twenty four point four four. 02:51.950 --> 02:55.670 So that's the easy way how to calculate a well you weighted index. 02:55.670 --> 02:58.430 But uh the easy way does not work. 02:58.430 --> 03:05.180 If for example one company issues additional shares to the market and we can have a look at an example 03:05.180 --> 03:06.330 here. 03:06.380 --> 03:14.510 So still we fear the stock prices then we fear the amount of shares and we assume now that Company A 03:14.540 --> 03:23.040 issues on the Times then one additional ten stocks so that in total we have 20 stocks that timestamp 03:23.060 --> 03:27.020 1 and we also assume that the stock price does not change. 03:27.020 --> 03:32.930 So it remains that 8 and the new investors also pay 8 dollars per new share. 03:33.170 --> 03:37.790 And again we can never look at the market capitalization. 03:37.790 --> 03:45.740 So we have actually an increase of total market value for stock a from 80 to 160 and this is not because 03:45.740 --> 03:52.250 of the performance of a company a stock a is so great it's simply because of the new investors paid 03:52.280 --> 03:56.210 in into the company 80 for the new 10 stocks. 03:56.210 --> 04:02.450 So for the investors of the already existing 10 shares there shouldn't be any impact actually but we 04:02.450 --> 04:06.850 can see here that the total sum of market cap increases to one hundred ninety two. 04:07.610 --> 04:14.840 And then if you simply calculate evaluated indexed as we have done before then we get the result that 04:14.960 --> 04:20.420 the value of our index that timestamp 1 is two hundred thirteen point three three. 04:20.440 --> 04:28.040 So this seems like existing investors that realized a great return in the period from timestamp 0 to 04:28.040 --> 04:28.330 1. 04:28.340 --> 04:31.080 But of course this is actually not the case. 04:31.280 --> 04:37.710 So this is here completely wrong what we did here and now I will show you the right way. 04:37.730 --> 04:40.390 And the more general way how to do this. 04:40.460 --> 04:49.760 So we still have our stock prices then we have our number of shares and then we have our market capitalization 04:50.450 --> 04:55.990 and then we calculate the weight of the constituents in proportion to the market capitalization. 04:56.690 --> 05:07.390 So the weight of stock at the time stem 0 is 50 divided by 90 is the 56 percent and consequently the 05:07.390 --> 05:10.270 weight for stock P S O point for 4. 05:10.600 --> 05:13.400 So these are the proportional market cap rates. 05:13.420 --> 05:17.250 And again here we have them and also we have the prices. 05:17.320 --> 05:20.560 And then finally we calculate the returns. 05:20.590 --> 05:22.930 So this is actually nothing new here. 05:22.930 --> 05:30.190 And for stock a BFA return in the period of 60 percent and for stock beef of minus 20 percent and then 05:30.190 --> 05:36.130 we simply have to calculate the weighted average return and we rate the returns of stock A and Stock 05:36.130 --> 05:43.000 B by the weights of their market capitalization at the beginning of the period and this is a 56 percent 05:43.370 --> 05:51.130 to 44 percent and still the initial index value is 100 and we calculate the weighted average return 05:51.130 --> 05:51.330 here. 05:51.340 --> 05:56.880 So 60 percent weighted with 56 percent and minus 20 percent. 05:56.920 --> 06:03.290 Multiply it by 44 percent and this gives a weighted average return of twenty four point four percent. 06:03.580 --> 06:11.430 And once we have the weighted average return then we can also calculate the index value at timestamp 06:11.470 --> 06:16.280 1 and this is again one hundred twenty four point four four. 06:16.330 --> 06:20.000 So that's again the more general approach where we wait. 06:20.050 --> 06:27.490 The returns of the constituents with the the respective rates and in case of a value weighted index 06:27.610 --> 06:31.280 the weights are determined by the market capitalizations. 06:31.370 --> 06:31.950 All right. 06:31.960 --> 06:39.100 And let's also go here to the pros and cons and the major advantage of the value weighted index is that 06:39.130 --> 06:47.170 it best reflects the aggregate market or the average investor portfolio and therefore as a second advantage 06:47.500 --> 06:51.580 the rates of the constituents are based on economic importance. 06:51.580 --> 06:58.840 So the companies with the highest values and the highest the economic impact have the highest weights 06:58.870 --> 07:03.390 and a value weighted index and finally same mess. 07:03.430 --> 07:04.810 The price weighted index. 07:04.820 --> 07:09.700 So typically a value weighted index does not require rebalancing. 07:09.820 --> 07:15.280 So the value weighted index is self rebalancing because there are no fixed rates. 07:15.280 --> 07:21.800 So if stock goes up and stock B goes down then that's the new rates and that's it actually. 07:21.820 --> 07:27.180 All right let's finally have a look at the disadvantages of a well you weighted index. 07:27.220 --> 07:33.910 So in most cases a regulated index shows some kind of over concentration in a few stocks with a high 07:33.910 --> 07:35.570 market capitalization. 07:35.710 --> 07:41.920 And this means that a value weighted index is compared for example to a equal weighted index a poorly 07:41.920 --> 07:50.030 diversified and some market participants argue that the highest valued stocks there may be the most 07:50.180 --> 07:51.880 overvalued stocks. 07:51.950 --> 07:57.410 So the major reason why they are highly valued is that they are actually overvalued. 07:57.410 --> 08:02.180 And some studies show that the value weighted index is actually underperform. 08:02.210 --> 08:03.590 Other indexes. 08:03.590 --> 08:10.010 And this is simply the case because overvalued stocks might perform poorly in the near future. 08:10.960 --> 08:13.310 And finally if I evaluated index. 08:13.360 --> 08:15.060 The data needs are quite high. 08:15.340 --> 08:16.490 So we need. 08:16.510 --> 08:22.090 The stock prices and then additionally we need to for each and every time stamp and for each and every 08:22.090 --> 08:25.430 constituent the shares outstanding. 08:25.480 --> 08:31.930 And if we are creating a free float market cap weighted index then in addition we need information on 08:31.930 --> 08:34.220 the free flow chairs. 08:34.360 --> 08:39.460 That's it for now and hope to see you also in the next videos that we will create our value weighted 08:39.460 --> 08:41.230 index with python by.