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Definition: Free Float Methodology
Free float methodology is an index construction methodology that employs or uses free float method to calculate the market capitalization of the underlying stocks of companies included in the index. Market capitalization of the company calculated through free float method gives a clearer picture of the company as compared to that of full market capitalization method. In case of free float methodology the market capitalization of a company is calculated by multiplying the number of shares that are available in the market for day to day trading and the price per share.
It does not include the number the number of shares that are locked in by the company either with the government or the promoters or with some strategic investors or shares of Employee Welfare Fund or shares of the company lying with any other associate company or FDI holdings of the company or other shares which are locked in by the company are not readily available for normal trading. So, the value obtained through free float market methodology is small as compared to that of fixed market capitalization. Free float methodology tends to give a more rational picture of the market value of the company. Moreover, it tends to reflect the market movements clearly. This method also helps to broaden the base of the index by involving various varieties of companies in the index rather than concentrating on only few ones. Hence, it tends to provide more flexibility to the index and enhance sector as well as market coverage. Both kinds of investors i.e. active as well as passive are benefitted through this methodology. Active managers can easily benchmark their returns to that of index while passive investors can easily track the index with minimum amount of tracking error being involved.
Some of the major indices of the world are calculated using this method such as FTSE, BSE, MSCI India Standard Index, NASDAQ-100 etc.