Answer Posted / himanshu
Under the 'full-market capitalization' methodology, the
total market capitalization of a company, irrespective of
who is holding the shares, is taken into consideration for
computation of an index. However, if instead of taking the
total market capitalization, only the Free-float market
capitalization of a company is considered for index
calculation, it is called the Free-float methodology.
Free-float market capitalization is defined as that
proportion of total shares issued by the company which are
readily available for trading in the market. It generally
excludes promoters' holding, government holding, strategic
holding and other locked-in shares, which will not come to
the market for trading in the normal course. Thus, the
market capitalization of each company in a Free-float index
is reduced to the extent of its Free-float available in the
market.
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Occasionally it is said that issuing convertible bonds is better than issuing stock when the firms shares are undervalued. Suppose that the financial manager of Decent Furniture Company does in fact have inside information indicating that the decent stock price is too low. Decent furniture earnings will in fact be higher than investor’s expectations. Suppose further that the inside information cannot be released without giving away a valuable competitive secret. Clearly, selling shares at the present low price would harm Decent’s existing shareholders. Will they also lose if convertible bonds are issued? If they do lose in this case, is the loss more or less than it would be if common stock is issued? Now suppose that investors forecast earnings accurately, but still under value the stock because they overestimate Decent’s actual business risk. Does this change your answer to the questions posed in the preceding paragraph? Explain.
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