What is Free-Float Methodology?

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The free-float methodology is a method of calculating the market capitalization of a stock market index's underlying companies. With the free-float methodology, market capitalization is calculated by taking the equity's price and multiplying it by the number of shares readily available in the market.Rather than using all of the shares (both active and inactive shares), as is the case with the full-market capitalization method, the free-float method excludes locked-in shares, such as those held by insiders, promoters, and governments.

Definition

The Free-Float Market Capitalization Method is a way to calculate the market capitalization of companies forming the basis of a stock market index. It calculates market capitalization by multiplying the share price by the number of shares available for trading in the market. Unlike the full market capitalization method, which uses all shares (active and inactive), the free-float method excludes locked-in shares, such as those held by insiders, promoters, and governments.

Origin

The origin of the Free-Float Market Capitalization Method dates back to the late 20th century when investors and analysts sought a more accurate index calculation method that better reflected market liquidity. As global financial markets became more open and transparent, this method gained widespread adoption.

Categories and Features

The Free-Float Market Capitalization Method is primarily used in calculating stock market indices, such as the S&P 500 and MSCI indices. Its feature is that it only considers the number of shares actually available for trading in the market, thus more accurately reflecting market liquidity and the actual operability for investors. In contrast, the full market capitalization method includes all shares, regardless of their tradability.

Case Studies

A typical case is the calculation of the S&P 500 index. The S&P 500 uses the Free-Float Market Capitalization Method to determine the weight of its constituent stocks, meaning only those shares actually available for trading in the market are included in the index's market capitalization calculation. Another example is the MSCI Emerging Markets Index, which also uses the free-float method to better reflect the actual investment opportunities available to investors in emerging markets.

Common Issues

Common issues investors face when using the Free-Float Market Capitalization Method include misunderstandings about the number of floating shares, which can lead to incorrect market capitalization calculations. Additionally, investors might mistakenly believe that all market capitalization calculation methods are the same, overlooking the unique aspects of the free-float method.

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Liquidity Trap

A liquidity trap is an adverse economic situation that can occur when consumers and investors hoard cash rather than spending or investing it even when interest rates are low, stymying efforts by economic policymakers to stimulate economic growth.The term was first used by economist John Maynard Keynes, who defined a liquidity trap as a condition that can occur when interest rates fall so low that most people prefer to let cash sit rather than put money into bonds and other debt instruments. The effect, Keynes said, is to leave monetary policymakers powerless to stimulate growth by increasing the money supply or lowering the interest rate further.A liquidity trap may develop when consumers and investors keep their cash in checking and savings accounts because they believe interest rates will soon rise. That would make bond prices fall, and make them a less attractive option.Since Keynes' day, the term has been used more broadly to describe a condition of slow economic growth caused by widespread cash hoarding due to concern about a negative event that may be coming.

Liquidity Crisis

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Liquidity Crisis

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Liquidity Event

A liquidity event is an acquisition, merger, initial public offering (IPO), or other action that allows founders and early investors in a company to cash out some or all of their ownership shares.A liquidity event is considered an exit strategy for an illiquid investment or equity with little or no market to trade on. Founders of a firm push toward a liquidity event, and investors like venture capital (VC) firms, angel investors, or private equity firms expect one within a reasonable amount of time after initially investing capital.

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Liquid Alternatives

Liquid alternative investments (or liquid alts) are mutual funds or exchange-traded funds (ETFs) that aim to provide investors with diversification and downside protection through exposure to alternative investment strategies. These products' selling point is that they are liquid, meaning that they can be bought and sold daily, unlike traditional alternatives which offer monthly or quarterly liquidity. They come with lower minimum investments than the typical hedge fund, and investors don't have to pass net-worth or income requirements to invest. Critics argue that the liquidity of so-called liquid alts will not hold up in more trying market conditions; most of the capital invested in liquid alts has entered the market during the post-financial crisis bull market. Critics also contend that the fees for liquid alternatives are too high. For proponents, though, liquid alts are a valuable innovation because they make the strategies employed by hedge funds accessible to retail investors.

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Zero-Investment Portfolio

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