What is Mark to Market (MTM)?
Mark to market is an accounting practice that estimates the current value of assets and liabilities over time that have fluctuations in their prices. The primary aim of a mark to market approach is to systematically and quickly evaluate the worth of the assets and liabilities of a business or an individual in order to take measures, where necessary. Having understood what mark to market is, let us go expound on this issue.
Understanding the Mark to Market (MTM)’s Meaning in Detail
It is mark to market (MTM) if we make any change in the positioning of any asset or liability with its market value. Any individual or entity that has marred an asset or liability does so from within or outside the horizontal boundaries of the entity.
Let’s say someone bought a share for ₹100. At the end of the day however, the price of the share is ₹95. Hence, he records a loss of ₹5 in his personal books of accounts to reduce the value of the share to ₹95. Fundamentally, he is reducing his asset’s value to its market price.
Let us take an example at a company’s level. Let’s say a firm owns a building, which is listed in their balance sheet with a value of Rs. 10 crores. However, due to the downturn in the economy, the fair market value of this asset is now about Rs. 9.2 crores. Therefore, the company will have to impair the asset by Rs. 80 lakhs in its books to show the market value of the building. Now that we have discussed what is the meaning of mark to market, let us seek to explore its value.
When it comes to Mark to Market (MTM), the following are its advantages:
Provides Valuation at Any Given Point in Time: Marking to market helps you in fathoming the value of an asset / liability as it exists in the present date. If not for mark to market, neither the individual nor the company will realize the amount or worth of their assets in the above-mentioned illustrations. Without understanding the worth of these assets, they would not be able to establish a knowing insight as to the value of their net-worth, which is rather unfortunate.
Accounting About the Basic Understanding: It does not matter whether you are an individual or a Company; in order for your understanding of the position of the Company to be complete you have to perform the exercise of marking to market the assets and liabilities of the Company. And if you just keep aging these assets or liabilities on some bargaining stretch at an inside the flat book value, you will never ever imagine how they have performed in the real outside market place. That is why marking to market is such a good performance measure.
The Need for Compliance: In most of the cases, the financial market regulators turn to the MTM method of valuation which is geared towards ensuring that every individual taking such a position has enough capital to cover the existing margins. In addition, several other financial instruments are required to be marked to market in order to ascertain their proper value for the safety of the investors and to maintain the economic stability.
Concerning Managing Risks: In the risk management sense, Mark-To-Market is of much help in that the investors are able to appreciate the actual worth of their asset or liability. Consider an instance where an investor purchases a certain equity most probably a stock. He has the option of taking a stop-loss order and at the same time monitor the price of the stock he has purchased (as in mark-to-market). In the event that the price of the stock begins to decline at a fast pace, the stop loss order and the fact that he is observing the market will serve to surrender any losses that may occur. However, if the order is not placed, losses can escalate out of proportion when the stock’s price drops significantly.
Transparency: When a firm values all the assets and liabilities as per the market conditions and standards, it gives all the interested parties such as the shareholders, the debtors, the clients, and even the government regulation bodies, a fair view of the company’s finances. This creates a high level of clarity since the interested parties receive current information instead of the old book values of the assets and liabilities in question.
Portfolio Monitoring: If you do not assess the market value of your positions held, it is impossible to assess any gains or losses that you have incurred in the course of trading. Therefore, portfolio monitoring is one of the most important advantages of mark to market. It will also assist you in determining which positions are most favorable to maintain, and which positions are best to close, when regularly marking the prices of your positions. Therefore, MTM is also important due to its influence in the making of decisions.
How does marking to market works in India?
In India also, the mark to market steers that the trader’s accounts will show credits for profits and debits for losses incurred. Thus, the equity position of the trader will change on day-to-day basis. A margin call is an alert given by a broker to a trader, if sustained adverse price changes cause the equity in a margin account to be equal to or less than the maintenance level.
To try and understand the mark to market process in the Indian context, let us assume that our trader purchases a stock called X on a futures contract on Monday when that stock is priced at ₹2,000.
Let us assume that the number of shares for one futures contract of stock X is 200. Let’s assume that for the futures contract, a trader is required to post an initial margin of ₹100,000 and maintenance margin of ₹80,000.
Let us assume now that the day after paying the difference of the futures contract, prices move to ₹2,100 on Tuesday, ₹1,950 on Wednesday, and ₹1,850 on Thursday. Below is how the changing price will affect the profit and loss of the trader.
The margin, however, will reduce to ₹70,000 by the end of Thursday meaning that this will be lower than the Maintenance Margin of ₹80,000. This means, therefore, that the broker will have to issue a Margin Call by the end of Thursday. As a consequence, either the trader will have to fund his margin account further or the broker will close his position.
| Day | Futures Price | P&L per share | Lot Size | Total P&L | Margin at Beginning | Margin at End |
| Monday | 2,000 | – | 200 | – | 1,00,000 | 1,00,000 |
| Tuesday | 2,100 | 100 | 200 | 20000 | 1,00,000 | 1,20,000 |
| Wednesday | 1,950 | -150 | 200 | -30000 | 1,20,000 | 90,000 |
| Thursday | 1,850 | -100 | 200 | -20000 | 90,000 | 70,000 |
Summary
Before one opens a trading account for the first time or even a professional trader, it is suggested that you grasp the idea of MTM in depth. The concept of different types of mark to market also deserves attention. In other words, you ought to know this both personally and corporately. This is important because you will understand the rationale behind the difference between the market value of a position and its book value and how it may affect your approach in trading.