A capitalisation-weighted index and an equal-weighted index hold the same securities and take the same last sale prices. Under the arithmetic in Nasdaq's Calculation Manual for equity indexes, which input must differ for their weights to differ?

The formula for a weight, which divides by the index total in one index and by the largest constituent's value in the other

The number of each security's shares applied in the index, which each index methodology specifies for itself

The divisor, which each index sets security by security so as to give every constituent its intended weight in the index

The spot exchange rate, which an equal-weighted index applies to every one of its securities while a capitalisation-weighted one does not

A dollar-denominated Nasdaq equity index holds a security that trades in euros. How does Nasdaq's Calculation Manual compute that security's index market value?

Its shares applied in the index times its price, times the exchange rate fixed at the last rebalance until the next one

Its shares applied in the index times its price, the currency effect being left out until the index level is reported

Its shares applied in the index times its price, times the spot exchange rate converting that price into dollars

Its shares applied in the index times its price, times the weight the security carries in its home market's main index

A client's portfolio holds the same fraction of every constituent's shares outstanding as a capitalisation-weighted index does. Over a month one constituent's price doubles while the others are unchanged, and no company issues or retires shares. What must the portfolio trade to stay in line with the index?

Nothing, since that constituent's index weight has risen in the same proportion as its value in the portfolio

Part of the holding that doubled, since the index restores each constituent's weight to its previous level at month-end

More of the other constituents, since the index adds shares of the laggards so that its sector balance is preserved

Part of the holding that doubled, since the index weights its constituents by their market values at the last review

Only twenty percent of a Nasdaq-100 company's shares outstanding are free-floating, the rest being held by its founders. On what share count does the index's modified market capitalisation weight the company?

Twenty percent of its shares outstanding, the free-floating shares alone and none of the founders' holdings

Sixty percent of its shares outstanding, the lesser of all of them and three times its free-floating shares

Eighty percent of its shares outstanding, four times its free float being the most the index will count

Forty percent of its shares outstanding, twice the free float being the most the index will count for a company

A Nasdaq-100 candidate has a large class of unlisted shares alongside its listed class. How does the index treat those unlisted shares when it selects companies and when it weights them?

They count in both measures, since the index ranks and weights each company on the value of every share it has issued

They count in the modified market capitalisation used for its weight, but not in the full market capitalisation used to rank it for selection

They count in the full market capitalisation used to rank it for selection, but not in the modified market capitalisation used for its weight

They count in neither measure, since the index ranks and weights each company on its listed share classes alone

A company meets every other Nasdaq-100 eligibility criterion, but only four percent of its shares are free-floating. How does that low float bear on its place in the index?

It does not bar the company now, though the company must reach a minimum float within a year or be deleted from the index

It bars the company until its free float reaches five percent, the minimum the index sets for every member it holds

It bars the company until a lock-up expires and lifts its free float above the minimum the index sets for new members

It does not bar the company, since there is no minimum free float criterion; the low float limits its weight instead

The Nasdaq-100 Equal Weighted Index holds one hundred issuers, one of which is represented by two listed share classes. Immediately after a quarterly rebalance, what weight does that issuer carry?

About one percent in total, apportioned equally between its two share classes

About one percent for each class, every security in the index carrying the same weight

About one percent in total, divided between the classes by each class's market value

About two percent in total, divided between the classes by each class's market value

In Nasdaq's index weight calculations, what role can an equal-weighting scheme play in building an index?

It produces the final weights in every index using it, since equal weights adjusted further would cease to be equal ones

It produces the final weights in some indexes, and in others serves as one adjustment stage that later rules adjust

It serves as a temporary stage between rebalances, held in place only until the constituents' market values are restored

It sets the starting weights in every index using it, each index then ending its weighting process with market values

Since the last quarterly rebalance of the Nasdaq-100 Equal Weighted Index, one security's price has doubled while the index as a whole is roughly flat. What happens to that security's index shares at the next rebalance?

They are doubled, since the rebalance adds shares to the securities whose prices have performed best

They stay the same, since index shares change only as a direct result of a corporate action such as a split

They are cut to about half, since each security's index shares are its equal index value divided by its price

They stay the same, the security's excess weight being removed by lowering the index divisor instead

A replacement company enters the Nasdaq-100 Equal Weighted Index in place of a deleted constituent. What weight does the replacement take when it enters?

The average weight of all the other constituents, measured at the close on the trading day before it enters the index

One-hundredth of the index, every replacement entering at a fresh equal weight on the day that it is added to the index

The weight its own market value would give it, until it is brought into line with the others at the annual reconstitution

The weight of the company it replaces, measured as of the prior month-end rather than on the day it enters

Nasdaq's corporate actions manual sets out alternate treatments for some corporate events. How do the Nasdaq-100 Index and the Nasdaq-100 Equal Weighted Index choose between them?

The Nasdaq-100 follows the Market Cap Corporate Action Method and the equal-weighted index the Non-Market Cap method

Both follow the Market Cap Corporate Action Method, corporate events being treated the same way in every Nasdaq index

Both follow the Non-Market Cap Corporate Action Method, since each of the two indexes applies weight constraints

The Nasdaq-100 follows the Non-Market Cap Corporate Action Method and the equal-weighted index the Market Cap method

An index of three securities with initial weights of fifty, thirty and twenty percent applies a forty percent cap to any one security under Nasdaq's weight adjustment guidelines. What are the final weights?

Forty, thirty-five and twenty-five percent, the ten points removed being shared equally by the other two securities

Forty, thirty-six and twenty-four percent, the ten points removed being shared in proportion to the other two weights

Forty, thirty and twenty percent, the ten points removed being held outside the index until the next rebalance

Forty, forty and twenty percent, the ten points removed going wholly to the next largest of the securities

Under Nasdaq's weight adjustment guidelines, can capping the largest weights in an index leave any constituent with a final weight of zero?

Yes, for a constituent whose initial weight is below the floor that the index's own methodology sets

Yes, where the excess taken from the capped units cannot otherwise be absorbed by the rest of the index

No; the guidelines bar any final weight of zero, so capping does not take a constituent out of the index

No, though a constituent cut below one tenth of a percent is then deleted from the index at the next rebalance

An index weights its constituents by a proprietary score rather than by market value. How do Nasdaq's index weight calculation definitions classify it?

As a capitalisation-weighted index, a class that also covers indexes weighting by total shares outstanding

As a free float index, a class that also covers indexes adjusting their weights by the share of stock that trades

As an equal-weighted index, a class that also covers indexes setting each unit to the same dollar value

As a modified weight index, a class that also covers indexes adjusting their weights to upper or lower bounds

At a Nasdaq-100 quarterly rebalance, one company's initial weight is twenty-six percent and another's is twenty-two percent. What does the first company-level weighting stage do to the two companies?

It brings both down to twenty percent, the twenty-six percent weight having set off the stage

It brings the larger down to twenty-four percent, leaving the twenty-two percent company where it stood

It cuts the larger to twenty percent and lifts the smaller to absorb part of the six points removed

It leaves both unchanged, the stage applying only once a company's weight passes thirty percent of the index

After the first company-level stage of a Nasdaq-100 rebalance, the seven companies weighing more than four and a half percent each together account for fifty-one percent of the index. What does the second stage do?

Reduces the seven companies' combined weight to forty-eight percent, the level at which the limit is set

Reduces the seven companies' combined weight to forty percent, the stages repeating until both limits are met

Reduces each of the seven companies to four and a half percent, the level above which the limit applies

Leaves the seven companies unchanged, the limit applying only once their weight reaches sixty percent

A company joins the Nasdaq-100 mid-quarter as the replacement for a deleted constituent. How is its initial weight in the index set?

At one hundredth of the index, each replacement entering at an equal weight until the next quarterly rebalance resets it

By its own modified market capitalisation, left uncapped until the next quarterly rebalance applies the company limits

By linear interpolation between the next largest and next smallest constituents, so that the index keeps its rank order

At the smallest weight in the index, so that the newcomer cannot displace any existing member from its place in the ranking

A company in the FTSE RAFI universe has paid no dividends in the past five years. How is its RAFI fundamental value calculated?

It has none, since a company paying no dividends is ineligible for the FTSE RAFI Index Series until it pays one

From the average of all four of its factor shares, its zero share of dividends pulling the figure down by a quarter

From its shares of the universe's sales and cash flow, both the book value and the dividend factors being dropped

From the average of its shares of the universe's sales, cash flow and book value, the dividend factor being dropped

The FTSE RAFI ground rules weight companies on four factors: sales, cash flow, book value and dividends. How does the measurement of book value differ from that of the other three?

Book value is taken at the review date, while the other three are averaged over the prior five years

Book value is averaged over the prior five years, while the other three are taken at the review date

Book value is averaged over the prior three years, while the other three are averaged over five years

Book value is taken at the previous review date, while the other three are taken at the current one

A large company listed its shares for the first time five months before a FTSE RAFI annual review. It has not yet reported annual figures, and none can be derived from any predecessor company. How is it treated at the review?

It is admitted on its market value until its fundamental data becomes available at the next annual review

It is ineligible, since a company whose fundamental data is not yet available cannot be scored at that review

It is admitted on the average fundamental value of the companies in its sector until it reports its figures

It is admitted on the figures for the months it has traded, annualised to stand for one full year of data

A FTSE RAFI constituent's share price doubles in the months after the March review while the rest of the index is flat and its fundamentals are unchanged. What happens to its index weight before the next review?

It stays at its fundamental weight until the company next publishes a full set of its annual figures

It stays at its fundamental weight, the adjustment factor being reset each day to cancel out the price change

It rises with the price, the adjustment factor set at the review staying fixed until the next review

It falls, the index cutting its adjustment factor as the stock becomes dearer relative to its fundamentals

A thinly traded company's fundamental weight in the FTSE RAFI universe is six times its liquidity weight, the latter measured from its median daily traded value. What do the ground rules do about it?

Leave its fundamental value unchanged, the liquidity weight being used only to select the companies

Exclude it from the index series, a ratio above four marking the company as too illiquid to be held

Reduce its fundamental value until the ratio falls to one, matching its weight to its liquidity weight

Reduce its fundamental value until the ratio falls to four, repeating the process until no company exceeds four

A company appears in a FTSE RAFI index through two lines of stock. How is its RAFI fundamental value applied to them?

It is calculated once for the company and allocated between the lines in proportion to investable market capitalisation

It is calculated once for the company and allocated equally between the two lines, whatever the size of each

It is calculated separately for each line, from the fundamentals attributable to that class of the company's shares

It is calculated once for the company and allocated wholly to the line that has the larger daily traded value

Nasdaq calculates both a price return version and a true price return version of some of its indexes. How do the two versions treat dividends?

The price return version reflects ordinary dividends but not special ones; the true price return version reflects neither

The price return version reflects special dividends but not ordinary ones; the true price return version reflects neither

The price return version reflects neither kind; the true price return version reflects special dividends but not ordinary

The price return version reflects neither kind; the true price return version reflects ordinary dividends but not special

Nasdaq calculates a gross total return index that is linked to a corresponding price return index. How are the two calculations connected?

They use separate divisors, the total return version adding each ordinary cash dividend on its payment date

They use the same index divisor, the total return version adding each ordinary cash dividend on its payment date

They use separate divisors, the total return version adding each ordinary cash dividend on its ex-distribution date

They use the same index divisor, the total return version adding each ordinary cash dividend on its ex-distribution date

A capped index applies its weight constraints at a quarterly rebalance, and the reweighting changes the index market value although no constituent's price has moved. What stops the rebalance itself from moving the published index level?

The divisor is recalculated so that the new index market value divided by it gives the level before the rebalance

The index shares are chosen so that the index market value comes out exactly where it was before the rebalance

The rebalance takes effect at the open, when the published level is reset by rule to the previous day's close

Nothing does, the move being reversed by an equal and opposite adjustment at the next quarterly rebalance

A company belongs both to a capitalisation-weighted Nasdaq index and to a FTSE RAFI index. Between FTSE RAFI reviews it splits its shares two for one, with no change in its business. What happens to its weight in each index?

Unchanged in the capitalisation-weighted index, but halved in the FTSE RAFI index

Unchanged in the capitalisation-weighted index, and unchanged in the FTSE RAFI index

Halved in the capitalisation-weighted index, but unchanged in the FTSE RAFI index

Halved in the capitalisation-weighted index, and halved in the FTSE RAFI index

At a FTSE RAFI annual review, two companies have identical records of sales, cash flow, book value and dividends, but the market values one of them at twice the other. How do their weights compare when the review sets them?

The cheaper company weighs twice as much, since the index favours the companies whose shares trade below their fundamentals

The dearer company weighs twice as much, since the weights set at a review follow each of the companies' market values

They are the same, since the weights set at a review rest on fundamental values rather than on market prices

The dearer company weighs more, though less than twice as much, since fundamentals and market prices count equally at review

A constituent is deleted from the Nasdaq-100 Index in the middle of a quarter. What happens to it in the Nasdaq-100 Equal Weighted Index?

It stays in the equal-weighted index at its last weight, which is frozen until the next annual review

It stays in the equal-weighted index until the next quarterly rebalance, when its membership is reviewed again

It stays in the equal-weighted index until the December reconstitution, when its whole membership is rebuilt

It is removed from the equal-weighted index at the same time as it leaves the Nasdaq-100 Index

Stock Index Weighting Methods | Financial Regulation Courses

What Is Stock Index Weighting and Why Does It Matter?

Stock index weighting is the rule that decides how much each constituent of an index counts toward the index's level and its return. Two indexes can hold exactly the same companies and still report different results, because one may weight its members by their market value, another may give every member the same weight, a third may weight them by share price, and a fourth may weight them by figures taken from their financial statements.

For an adviser, the weighting rule explains what a benchmark measures and what a fund that tracks it will hold. This article sets out the main schemes as the index providers describe them in their published methodologies, principally Nasdaq's index methodologies and calculation manual and the FTSE Russell ground rules.

What an Index Weight Is

Every equity index built by an index provider rests on the same arithmetic. Nasdaq's Calculation Manual for equity indexes defines the index market value of each index security as the number of its shares applied in the index multiplied by its price, and, for a security priced in another currency, by the spot exchange rate. The index market value of the whole index is the sum of those figures across its securities, and each security's index weight is its own index market value divided by the index market value of the whole index.

The manual adds that the number of shares applied in the index can be based on any number of items, which each specific index methodology identifies. That single input is where weighting schemes part company. A capitalisation-weighted index applies the company's shares outstanding, a float-adjusted index applies only the portion of those shares available for trading, and an equal-weighted or capped index applies whatever number of index shares produces the weight its rules call for.

Nasdaq's weight calculation guidelines state that index shares are generally set so that, on the rebalance reference date, a security's index shares multiplied by its last sale price produce the weight the methodology prescribes. Once set, the share count stays put. The Nasdaq-100 methodology and its equal-weighted counterpart both state that, other than as a direct result of corporate actions, the index does not normally experience share adjustments between scheduled reconstitution and rebalancing events. Between those events, therefore, each weight moves only with the security's price performance relative to the other members.

Market Capitalisation Weighting

Nasdaq's guide to index weight calculations defines a market capitalisation-weighted index as one whose security weights are based on market capitalisations, generally found by multiplying each security's last sale price by its total shares outstanding. Each security's weight is its market capitalisation divided by the aggregate market capitalisation of all the index securities. The largest companies by market value therefore carry the largest weights, and the method is the starting point from which most other schemes are built.

Because the share count applied to each company is its own share count, a capitalisation-weighted index stays in proportion to the market as prices move. If one constituent's price doubles while the others are unchanged, its weight rises because its market value has risen, and an investor holding the same proportion of every company's shares holds a portfolio that has moved in exactly the same way. No purchase or sale is needed to keep that portfolio in line with the index. Trading is needed only when the shares applied change, for example when a company issues or retires shares or when constituents join or leave.

The same property explains the familiar criticism of the method: a handful of very large constituents can come to dominate the return. Equal, capped and fundamental weighting each answer that concentration, and each gives up some of the self-adjusting simplicity described above.

Free Float and Limits on Low-Float Securities

Most broad benchmarks do not count every share a company has issued. Nasdaq defines a free float market capitalisation-weighted index as one that multiplies each security's last sale price and total shares outstanding by a float factor equal to the proportion of total shares outstanding available for trading. FTSE Russell describes its US indexes as float-adjusted and weighted by market capitalisation. Its ground rules adjust a security's shares to include only those available to the public, so as to exclude from market calculations the capitalisation that is not available for purchase.

The Nasdaq-100 Index takes a different route. For weighting it uses what its methodology calls modified market capitalisation, which counts only the eligible listed share classes and disregards foreign-listed and unlisted shares. To preserve investability for low-float securities, it then caps each low-float security's total shares outstanding at three times the number of its free-floating shares, so a security's modified market capitalisation uses its price and the lesser of its reported shares outstanding and three times its free float. A company whose free float is twenty percent of its shares is weighted on sixty percent of its shares outstanding; a company with a free float of one third or more is weighted on all of them.

The methodology states that there is no minimum free float criterion for the Nasdaq-100: a low float limits a security's weight rather than keeping it out of the index. The measure used to select companies is also different from the one used to weight them. For selection, the Nasdaq-100 ranks companies by full market capitalisation, which for a direct listing includes both listed and unlisted shares, while weights are calculated from the narrower modified market capitalisation.

Price Weighting

A third scheme weights each component by its share price rather than by the market value of the company. State Street's fact sheet for the SPDR Dow Jones Industrial Average ETF Trust, as of 30 September 2026, describes the Dow Jones Industrial Average as a price weighted index of thirty component common stocks, and states that the trust seeks investment results that, before expenses, correspond generally to the price and yield performance of that index.

The mechanics of the Dow Jones Industrial Average, including the maintenance of its divisor, are treated in the entry on that index.

Equal Weighting

Nasdaq describes equal weighting as adjusting index weights to achieve equal dollar values across units. Some indexes use equal weighting to produce their final weights; others use it during one or more stages of a weight adjustment, as an input to be adjusted further. The Nasdaq-100 Equal Weighted Index is the equal-weighted version of the Nasdaq-100 Index and contains the same securities, so the two indexes differ only in how those securities are weighted.

The unit that is made equal is the issuer, not the security. The methodology rebalances the index quarterly so that every issuer is assigned an equal index market value, and for an issuer represented by more than one security that issuer's index market value is apportioned equally across its index securities. An issuer with two listed share classes in an index of one hundred issuers therefore carries about one percent of the index after a rebalance, split evenly between its two classes, rather than about one percent for each class.

Index shares are then found by dividing each index security's index market value by its last sale price. A security whose price has doubled since the previous rebalance is therefore given about half as many index shares at the next one, and a security whose price has halved is given about twice as many. Each rebalance accordingly sells part of the holdings that have risen most and buys more of those that have fallen, which is why an equal-weighted index trades far more than a capitalisation-weighted index of the same companies, and why its weights drift away from equality again as soon as prices move after each rebalance.

Maintaining an Equal-Weighted Index Between Rebalances

The Nasdaq-100 Equal Weighted Index follows the same reconstitution and rebalancing schedule as the Nasdaq-100 Index. Its quarterly rebalance uses last sale prices as of the close of trading on the last trading day of February, May, August and November, and the changes take effect at the market open on the first trading day following the third Friday of March, June, September and December.

Membership moves in step with the parent index. If a constituent is removed from the Nasdaq-100 Index for any reason, it is removed from the equal-weighted index at the same time, and a security added to the Nasdaq-100 Index for any reason is added to the equal-weighted index at the same time. A replacement company does not enter at a fresh equal weight: it assumes the weight of the company it replaces as of the prior month-end, or, where fewer than seven trading days separate that month-end from the replacement effective date, as of the month-end two months before. The newcomer thus inherits a weight that already reflects the departing company's drift since the last rebalance, and exact equality is restored only at the next quarterly rebalance.

Corporate actions are handled according to the weighting scheme. Nasdaq's corporate actions manual describes alternate methods for some events, and the two methodologies choose between them differently: the Nasdaq-100 Index follows the Market Cap Corporate Action Method, while the equal-weighted index follows the Non-Market Cap Corporate Action Method. Two indexes with identical members can therefore respond differently to the same corporate event because the treatment follows how each index weights its members.

Modified Weighting and the Mechanics of Capping

Nasdaq's guidelines define modified weight indexes as those whose security weights depend on weighting by another data set, such as a proprietary score, or that adjust security weights to respect upper or lower bounds on eligible index weights. Every modified weight index undergoes a weight adjustment procedure at its rebalance. The procedure begins from initial weights, applies weight constraints, and produces final weights. A constraint may be a cap, which a weight may not exceed, or a floor, which it may not fall below, and it may apply to a security, an issuer, an industry, a country or any other group of constituents.

A unit whose adjusted weight would breach a cap is set equal to the cap and is called capped. The weight removed from capped units does not disappear, because the weights must still sum to one hundred percent. Within a capping level, all of the uncapped securities share a single adjustment factor, which is the ratio of a unit's final weight to its initial weight. Sharing one factor spreads the excess across the uncapped securities in proportion to their initial weights. In an index of three securities weighted forty, thirty and thirty percent under a thirty-five percent cap, the largest is set to thirty-five percent and the five points removed are shared equally by the other two, which finish at thirty-two and a half percent each.

Three further principles govern the procedure. Within each capping level the ranked order of final weights is generally kept consistent with the ranked order of initial weights, so capping does not make a larger constituent smaller than one that began below it. Adjustments may not result in any final weight of zero, so a capping procedure never removes a constituent from the index. For a floor, the procedure uses the higher of the constraint and the adjusted weight, rather than the lower, so a floor lifts small weights in the way a cap pulls down large ones.

Capping in Practice: The Nasdaq-100 Constraints

The Nasdaq-100 Index employs a modified market capitalisation weighting scheme. At each quarterly rebalance its initial weights, calculated from modified market capitalisation, are tested against company-level constraints in two stages. In the first stage, if any company's initial weight exceeds twenty-four percent, the weights are adjusted so that no company's weight exceeds twenty percent. In the second stage, the weights of all companies weighing more than four and a half percent are added together; if that sum is forty-eight percent or greater, the group's aggregate weight is reduced to forty percent, and to preserve rank order companies below four and a half percent may also be adjusted downward. The two stages are repeated until both constraints are met.

The trigger and the target are deliberately different numbers. A company whose weight has drifted to twenty-two percent breaches nothing, because only a weight above twenty-four percent sets off the first stage, and once that stage runs it takes the company down to twenty percent rather than to twenty-four. Between scheduled rebalances, a special rebalance may be triggered if, on end-of-day values, any company's weight exceeds twenty-four percent or the aggregate weight of the companies above four and a half percent exceeds forty-eight percent. Notice of a special rebalance, with its reference and effective dates, is published in advance.

At the annual reconstitution in December, security-level constraints follow the company-level stages: any security above fifteen percent is brought down to fourteen percent, and if the five largest security weights together reach forty percent or more they are reduced to thirty-eight and a half percent, with every security outside the five largest capped at the lesser of four point four percent or the fifth-largest weight. A security added between reconstitutions, whether as a replacement, a fast entry or at a quarterly rebalance, has its initial weight set by linear interpolation between the next largest and next smallest index constituents, based on modified market capitalisation ranking, so that the index keeps its rank order.

Fundamental Weighting: Building the Weight

Fundamental weighting replaces market value with measures of a company's economic size. The FTSE RAFI Index Series, built on the Research Affiliates Fundamental Index approach, weights its constituents using specific fundamental factors rather than market capitalisation, and its ground rules state that, at review, constituent weights are therefore not based on price valuations established by the market. Two companies with identical sales, cash flow, book value and dividends receive the same fundamental value at a review even if the market values one of them at twice the other.

The ground rules use four factors taken from each company's annual returns: sales averaged over the prior five years, cash flow averaged over the prior five years, book value at the review date, and total dividend distributions averaged over the last five years. Book value alone is taken at a single date rather than averaged. Where a company has fewer than five years of data, the factors average as many years as are available. Each company's share of the universe total is calculated for each factor, and its RAFI fundamental value is ten million times the average of those four percentage figures.

A company that has paid no dividends in the past five years is not marked down for it. Its RAFI fundamental value is instead ten million times the average of the three remaining figures for sales, cash flow and book value. A company whose fundamental data is not yet available and cannot be derived from predecessor companies is ineligible at the review; the ground rules give recent listings, recently merged companies and investment entities that do not report the necessary data as examples. A newly listed company that a capitalisation-weighted index would admit on its market value alone may therefore have to wait for a fundamentally weighted one.

The FTSE RAFI Index Series is reviewed annually in March, using data as at the close of business on the last trading day of January, and the review is implemented after the close on the third Friday of March. Target weights are set using prices as at the Monday four weeks before the review effective date. To turn fundamental values into index weights, FTSE Russell calculates an adjustment factor for each constituent by dividing its investable fundamental value by its investable market capitalisation, and applies that factor to the constituent's investable market capitalisation in the index formula. On the day the factor is set, the market capitalisation effect cancels out and the constituent's weight equals its fundamental weight.

After the review the factor is fixed, so the ground rules note that the price performance of each stock is still captured in the index calculation, as are corporate actions such as rights issues that affect the price. A constituent whose shares double between annual reviews carries a larger weight until the next review resets it, exactly as a capitalisation-weighted index would let it grow in the meantime.

Two further rules shape the weights. A liquidity limit compares each company's fundamental weight with its liquidity weight, measured from the higher of its thirty-day and ninety-day median daily traded value; where the ratio of the first to the second exceeds four, the company's fundamental value is reduced to the level that gives a ratio of four, and the process is repeated until no company exceeds the limit. And the fundamental value is calculated for the company rather than for each security: where a company is represented by two or more lines of stock, its fundamental value is allocated among them in proportion to investable market capitalisation.

Price Return, Total Return and Net Total Return Versions

The weighting scheme decides how much each security counts; the return version decides what the index counts about it. Nasdaq's Calculation Manual sets out several versions. The price return index reflects changes in the market value of index securities and is calculated without regard to ordinary dividends, although it does reflect special dividends. A true price return index is calculated in the same manner except that it disregards special dividends as well as ordinary ones.

The gross total return index reinvests cash dividends, taking each ordinary cash dividend into the calculation on its ex-distribution date. In its linked form it uses the same index divisor as the corresponding price return index, so the two versions differ only in the dividends reinvested. The net total return index also reinvests cash dividends, but only after deducting withholding tax at each security's incorporation withholding tax rate, which the manual defines as the percentage of dividends that must be withheld for non-resident investors who do not benefit from double taxation treaties.

The Index Divisor Across Weighting Schemes

Every scheme described here produces an index market value, and every one of them divides that value by a divisor to obtain the published level. Nasdaq's Calculation Manual explains that the divisor scales the index market value down to a lower order of magnitude for reporting and is adjusted so that changes in an index security's price or shares, whether caused by corporate actions or by index participation, which occur outside trading hours do not affect the index value. A divisor change occurs after the close of the index, and the new divisor equals the start-of-day index market value divided by the previous index value. The FTSE RAFI ground rules describe their divisor in the same terms, as a figure that can be adjusted to allow changes in the share capital of individual securities without distorting the index.

Index participation is the important phrase for the non-market-value schemes. When an equal-weighted index rebalances, or a capped index applies its constraints, every constituent's index shares may change at once, and the index market value changes with them although no price has moved. The divisor is recalculated so that the rebalance itself leaves the index level where it was; the level then moves only with the prices of the reweighted constituents.

A stock split shows how the treatment follows the scheme. Under the Calculation Manual's formula, a two-for-one split in a capitalisation-weighted index halves the price and doubles the shares applied, so the security's index market value is unchanged and the split itself calls for no divisor change. The FTSE RAFI ground rules state the outcome for their series directly: where a constituent has a stock split, a stock consolidation, a rights issue, a bonus issue or a change in the number of shares in issue, its weighting in the series remains unchanged before and after the event, and the index is adjusted in line with the ex-date.

Fund Diversification Rules and Concentrated Indexes

Weighting matters to fund sponsors because a fund that tracks an index holds what the index holds. Section 851(b)(3) of the Internal Revenue Code requires a regulated investment company, at the close of each quarter of its taxable year, to have at least fifty percent of the value of its total assets in cash, government securities, securities of other regulated investment companies and other securities limited, for any one issuer, to five percent of its total assets and ten percent of the issuer's outstanding voting securities, and to have not more than twenty-five percent of its total assets in the securities of any one issuer, other than government securities and the securities of other regulated investment companies.

Section 851(d)(1) adds that a company meeting those requirements at the close of a quarter does not lose its status merely because market movements later take its holdings out of line with them. A capped index sets explicit ceilings on single-company and aggregate weights within the index itself. The diversification tests that apply to funds are treated in their own entries.

Comparing the Weighting Schemes

Each scheme answers a different question about the market. A capitalisation-weighted index measures the performance of the market as investors collectively own it, and a fund tracking it needs to trade only when the index's shares change. A float-adjusted index narrows that to the shares investors can actually buy. A price-weighted index such as the Dow Jones Industrial Average weights its members by share price rather than by market value. An equal-weighted index measures the average performance of its members, gives its smaller members far more influence than market value would, and must trade at every rebalance to restore equality.

A capped index keeps the capitalisation-weighted shape but sets ceilings on the largest weights, redistributing the excess to the uncapped members in proportion to their weights. A fundamentally weighted index breaks the link between weight and market price at each review, so a company whose shares the market has bid up relative to its sales, cash flow, book value and dividends gains no extra weight from that rise when the weights are reset, although between reviews its weight moves with its price.

Common Errors and Exam Traps

The most frequent error is treating every major index as capitalisation-weighted. Price-weighted indexes, equal-weighted indexes, capped indexes and fundamentally weighted indexes all exist, and each responds differently to the same price movements and corporate actions.

A second error is assuming that an equal-weighted index stays equal. Its weights are equal only immediately after a rebalance; between rebalances they drift with prices, and a replacement company enters at the weight of the company it replaces rather than at a fresh equal share.

A third error is reading a cap's trigger as its target. Under the Nasdaq-100 company-level constraint, the twenty-four percent figure sets off the adjustment and the twenty percent figure is where the adjustment ends.

A fourth error is assuming that capping removes constituents or reshuffles their order. Capping lowers the largest weights, spreads the excess across the uncapped members in proportion to their weights, preserves rank order within a capping level and never produces a weight of zero.

Examination Relevance and Key Takeaways

Weighting methodology appears on the Series 65 and Series 66 examinations and on the SIE wherever benchmarks, index funds and exchange-traded funds are discussed. Candidates should be able to say how each scheme sets a constituent's weight, what happens to that weight when prices move, when the scheme requires trading, and how capping, equal weighting and fundamental weighting change the exposure a tracking fund delivers compared with a plain capitalisation-weighted index.