A:

The S&P 500 is a U.S.market index that gives investors an idea of the overall movement in the U.S.equity market. The value of the S&P 500 constantly changes based on the movement of 500 underlying stocks. The index is computed by weighted average market capitalization.

The first step in this methodology is to compute the market capitalization of each component in the index. This is done by taking the number of outstanding shares of each company and multiplying that number by the company's current share price, or market value. For example, if Apple Computer has roughly 830 million shares outstanding and its current market price is $53.55, the market capitalization for the company is $44.45 billion (830 million x $53.55). Next, the market capitalizations for all 500 component stocks are summed to obtain the total market capitalization of the S&P 500, as illustrated in the table below. This market capitalization number will fluctuate as the underlying share prices and outstanding share numbers change.

sp500.gif

In order to understand how the underlying stocks affect the index, the market weight (index weight) needs to be calculated. This is done by dividing the market capitalization of a company on the index by the total market capitalization of the index. For example, if Exxon Mobil's market cap is $367.05 billion and the S&P 500 market cap is $10.64 trillion, this gives Exxon a market weight of roughly 3.45% ($367.05 billion / $10.64 trillion). The larger the market weight of a company, the more impact each 1% change will have on the index. For example, if Exxon Mobil were to rise by 20% while all other companies remained unchanged, the S&P 500 would increase in value by 0.6899% (3.45% x 20%). If a similar situation were to happen to The New York Times, it would cause a much smaller, 0.0076% change to the index because of the company's smaller market weight.

(To learn more, check out Index Investing Tutorial and You Can't Judge An Index Fund By Its Cover.)

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