CFAI text volume 4 page 287 states “In cross-holding, one company owns shares of another, so including the full capitalization of both companies in an index is double counting.”
How does including full capitalization of both leads to double counting? Can someone please explain. Thanks.
Co. A has 1000 Shares. Co. B has 1000 shares.
A owns 100 shares of B. But B still continues to show its market cap with 1000 shares. (not 900)
B owns 200 shares of A. But A still shows 1000 not 800.
Think of it as adding the caps together . If each company owned no part of the other , the caps would add up equal to the sum of their capitalizations.
Otherwise to get the proper sum you would have to deduct any part they own of each other otherwise you’d double count .
A shows cap as $1000
B shows cap as $1000
if A’s cap is 50% invested in B then the toal cap is A’s cap + ( 50% of B’s cap not held by A)