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What is the Definition of Weighted Average?
Weighted average is a calculation that takes into account the relative importance of different values. It is a type of average that assigns different weights to each value in the set. This type of average is commonly used in finance and economics to assign a value to a portfolio or to measure the cost of capital.
How is Weighted Average Calculated?
The weighted average is calculated by multiplying each value in the set by its corresponding weight, summing the values, and then dividing the sum by the total of the weights.
For example, if a portfolio has four assets with the following values and weights:
Asset 1: $50 (weight of 0.2)
Asset 2: $100 (weight of 0.3)
Asset 3: $150 (weight of 0.4)
Asset 4: $200 (weight of 0.1)
The weighted average of the portfolio would be calculated as follows:
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(50 x 0.2) + (100 x 0.3) + (150 x 0.4) + (200 x 0.1) = $125
The sum of the weights is 0.2 + 0.3 + 0.4 + 0.1 = 1
The weighted average is then calculated by dividing the sum of the weighted values ($125) by the sum of the weights (1):
$125 / 1 = $125
Why is Weighted Average Used?
Weighted average is used to assign a value to a portfolio or to measure the cost of capital. It is also used to determine the average grade in a class, where each assignment or test has a different weight. This type of average is also used in statistics to calculate the average of a set of values where each value has a different importance.