Posted in Finance, Accounting and Economics Terms, Total Reads: 538
Definition: Mark to Market (MTM)
Mark To Market is method of accounting that tries to identify the fair value of an asset or liability based on the current market price of it or assets and liabilities that can be used as a proxy for it. This market value is considered for all accounting activities rather than the book value which is deemed to be the historical price and not a reflection of the current situation. Here market price denotes the price at which the asset is trading currently. The use of Mark to Market principles originated from the early future exchanges where it was used a method to maintain daily margin calls.
In case of the futures market, the trader has to deposit a fixed amount with the exchange for trading which is known as the margin. Now at the end of a day’s trading the value of the contracts of the trader is marked to their respective market prices and in case on a whole the trader is at a loss and the differential is more than the margin amount that is required by the exchange, then the trader is asked to pay up the differential in order to continue trading.
Another simple example is to consider that an individual bought 1000 stocks at their book value of Rs 3. So the book value of the stocks owned by him is Rs. 3000. On the other hand the current price of the stock may be Rs 10 in which case the Mark To Market price of the stocks owned by him is Rs 10000 (Rs 10 x1000).
Mark to Market accounting has been blamed by many as one of the culprits contributing to the financial crisis of 2008. The primary reason is the failure of the technique to correctly depict the underlying value of an asset in times of distress. As the market prices during the distress may not have fully reflected the underlying cash flows, so it many cases the prices of securities were actually marked down than their actual value leading to widespread losses and margin calls.