CFA Level I Exam · Benchmarking Returns

Index Construction and Weighting Methods: Price, Equal and Market-Cap Weighted

Updated 7 October 2026 · Fact-checked

An index tracks a group of securities using a weighting rule. A price-weighted index averages prices, so high-priced stocks dominate. An equal-weighted index gives each security the same weight. A market-cap-weighted index weights by market value, using free-float shares in float-adjusted versions. Compute the index value, then the return from the change.

Understand Index Construction and Weighting Methods

A market index measures the performance of a group of securities that represents a market, sector or asset class. To build one, you choose the target market, select the securities, pick a weighting method, set rules for rebalancing and reconstitution, and compute the index value.

The weighting method decides how much each security affects the index return. In a price-weighted index, weight is the security's price divided by the sum of all prices. A stock at 200 counts twice as much as a stock at 100, whatever the size of the company. The index value is the sum of prices divided by a divisor. A stock split cuts the price and so cuts that stock's weight, which is why the divisor must be adjusted after a split.

In an equal-weighted index, each security has the same weight, 1/N, at the start of each period. The return is the simple average of the security returns. As prices move, weights drift, so the index must be rebalanced back to equal weights. This creates higher turnover and trading costs. It also tilts toward small companies compared with a cap-weighted index.

In a market-capitalization-weighted index, weight is market cap (price × shares outstanding) divided by total market cap. A float-adjusted index uses only shares available to the public, excluding strategic holdings by governments, founders or other companies. Cap weighting needs little rebalancing because weights move with prices. The cost is that it holds more of stocks that have risen and so may overweight overvalued stocks.

Other schemes include fundamental weighting (by sales, earnings, dividends or book value), which breaks the link between weight and price, and factor-based weighting. Fundamental weighting gives a value tilt and contrarian behavior but departs from the market portfolio and may have higher turnover.

Key formulas to remember

Price-weighted index value: Index = Σ prices ÷ divisor; Initial divisor is often the number of stocks. Adjust the divisor after splits so the index value does not change.
Price weight of a security: w(i) = P(i) ÷ Σ P; Highest-priced stock has the greatest influence.
Equal-weighted index return: R = (R1 + R2 + … + RN) ÷ N; Simple average of returns, assuming weights reset to 1/N at the start of the period.
Market-cap weight: w(i) = (P(i) × Shares(i)) ÷ Σ (P × Shares); Use free-float shares for a float-adjusted index.
Float-adjusted market cap: Price × shares outstanding × free-float factor; Free float factor is the share of shares available to the public.
Index return from index levels: Return = (Index end ÷ Index start) − 1; Price return only unless the index is a total return index.
Weighted return: R(index) = Σ w(i) × R(i); Works for any scheme, with the weights at the start of the period.
Divisor after a split (price-weighted): New divisor = Σ adjusted prices ÷ old index value; Choose the new divisor so the index is unchanged right after the split.

How to solve Index Construction and Weighting Methods questions

Use the same routine for any index weighting question. Pay attention to the starting weights, since returns are earned on starting values.

1Identify the weighting method named in the stem: price, equal, market-cap, float-adjusted or fundamental.
2List the starting prices, shares, free-float factors and ending prices for each security.
3Compute the starting weights under the method (price share, 1/N, or cap share).
4Compute each security's return, or compute the index level at the start and end.
5Apply the method: Σ w × R, simple average for equal weight, or the ratio of index levels.
6Check special events such as splits, which change the divisor in price-weighted indexes.
7Match your answer to the three options and sanity-check it against the range of individual returns.

Quickest way: Shortcut by weighting type

When to use it: Use when you need a fast return under the 90-second guide per question.

Price-weighted: return = Σ price change ÷ Σ starting price. You do not need the divisor.
Equal-weighted: add the individual returns and divide by N.
Cap-weighted: return = Σ change in market cap ÷ Σ starting market cap.
Eliminate options outside the lowest and highest security returns.
For conceptual items, match the bias: price weighting is arbitrary to splits, equal weighting is small-cap tilted, cap weighting is momentum or overvaluation tilted.

Common mistakes in Index Construction and Weighting Methods

Averaging returns for a price-weighted or cap-weighted index.
Equal weighting is the easiest method, so it becomes the default.
Fix: Use the weights the method implies. A simple average belongs only to equal weighting.
Using ending values to set weights.
Candidates grab the latest data in the table.
Fix: Weight with starting values. Return over a period is earned on the beginning weights.
Using total shares instead of free-float shares in a float-adjusted index.
Market cap is remembered as price × shares outstanding.
Fix: Multiply by the free-float factor when the index is float-adjusted.
Treating a stock split as a price drop that lowers the index.
The price fall is visible but the divisor adjustment is overlooked.
Fix: Recompute the divisor so the index is unchanged immediately after the split. The split does change future weights.
Saying cap weighting needs frequent rebalancing.
Confusion with equal weighting.
Fix: Cap weights drift with prices automatically. Equal weighting needs rebalancing, hence higher turnover.
Mixing up the biases.
The three methods have similar-sounding drawbacks.
Fix: Remember: price = arbitrary weights, equal = small-cap tilt and turnover, cap = overweights stocks that have risen.

Worked examples

Example 1

An index holds three stocks. Starting prices: X 20, Y 40, Z 60. Ending prices: X 24, Y 38, Z 69. What is the price-weighted index return? A) 6.5% B) 9.2% C) 12.4%

Show the solution

Starting sum of prices = 20 + 40 + 60 = 120.
Ending sum of prices = 24 + 38 + 69 = 131.
Return = 131 ÷ 120 − 1 = 1.09167 − 1 = 9.17%.
For comparison, the individual returns are X +20%, Y −5% and Z +15%. The equal-weighted return = (20% − 5% + 15%) ÷ 3 = 10.0%.
This differs slightly from the price-weighted 9.17% because the weights differ. Price weights are X 16.7%, Y 33.3% and Z 50%, so X (+20%) counts for less than under equal weighting, while Z (+15%) counts for more.

Answer: B) 9.2%

Exam tips

Questions are three-option and independent, so compute quickly and eliminate options outside the range of single-stock returns.
Expect conceptual items on biases: price weighting is split-sensitive, equal weighting favors small caps, cap weighting favors recent winners.
Read whether the question says float-adjusted and use the free-float factor.
Remember that the cap-weighted index mirrors the market portfolio in the CAPM sense and needs little rebalancing.
Show weights at the start of the period; return questions that give ending data are traps.

Practice questions from Benchmarking Returns

Index Construction and Weighting Methods in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Index Construction and Weighting Methods: frequently asked questions

What is the difference between price-weighted, equal-weighted and market-cap-weighted indexes?

A price-weighted index weights by share price, an equal-weighted index gives every security the same weight, and a market-cap-weighted index weights by market value. Each gives a different return from the same stocks. The choice sets the index's biases.

How do you calculate a price-weighted index return?

Add the ending prices, add the starting prices, and divide the first by the second, then subtract 1. You do not need the divisor if no split occurred. If a split happened, adjust the divisor first.

What is a float-adjusted market-cap index?

It weights each stock by the market value of shares available to the public. Shares held by governments, founders or other strategic holders are excluded. This reflects what investors can actually buy.

Why does an equal-weighted index have higher turnover?

Prices move, so weights drift away from 1/N. The index must sell winners and buy losers to restore equal weights. That trading raises turnover and costs.