Mark to market
Encyclopedia : M : MA : MAR : Mark to market
In economics, mark to market is the act of assigning a value to a position held in a financial instrument based on the current market price for that instrument, or on a fair valuation based on the current market prices of similar instruments.
History and development
The practice of mark to market as an accounting device first developed among traders on futures exchanges in the 19th century. It wasn't until the 1980s that the practice spread to banks and corporations far from the traditional exchange trading pits, and beginning in the 1990s, mark-to-market accounting began to give rise to scandals.
To understand the original practice, consider that a futures trader, when taking a position, deposits money with the exchange, called a "margin". This is intended to protect the exchange against loss. At the end of every trading day, the contract is marked to its present market value. If the trader is on the winning side of a deal, his contract has increased in value that day, and the exchange pays this profit into his account. On the other hand, if he is on the losing side, the exchange will debit his account. If he cannot pay, then the margin is used as the collateral from which the loss is paid.
Over-the-counter (OTC) derivatives on the other hand are not traded on exchanges, so their market prices are not as readily available. During their early development, OTC derivatives such as interest rate swaps were not marked to market frequently. Deals were monitored on a quarterly or annual basis, when gains or losses would be acknowledged or payments exchanged.
As the practice of marking to market caught on in corporations and banks, some of them seem to have discovered that this was a tempting way to dress up the books, especially when the market price could not be objectively determined (because there was no real day-to-day market available), so assets were being marked to model, and sometimes marked to fantasies. See Enron.
Simple example
As an example, if an investor owns 100 shares of a particular stock purchased originally for $40 per share, and that stock is currently trading at $60 per share, then the "mark to market" value of the investor's shares is equal to (100 shares × $60), or $6000, whereas the Book value might (depending on the accounting principles used) only equal $4000.
See also
From Wikipedia, the Free Encyclopedia. Original article here. Support Wikipedia by contributing or donating.
All text is available under the terms of the GNU Free Documentation License See Wikipedia Copyrights for details.