What is Mark to Market (MTM)?
Mark to market is a method which is used to find the fair value of those assets and liabilities that are subject to periodic changes in their prices. The objective of mark to market is to provide a timely appraisal of the value of a business’s or an individual’s assets and liabilities so that corrective active can be taken, if needed. Having learnt what mark to market is, let us delve deeper into this topic.
Understanding the Mark to Market (MTM)’s Meaning in Detail
When we adjust the value of an asset or liability so that it reflects its current market value, it is called mark to market (MTM). The need to mark an asset or liability to market can be felt at an individual’s level or at a company’s or institution’s level.
Suppose an individual buys a share at ₹100. But, at the end of the day, the price of the share drops to ₹95. Consequently, he records a loss of ₹5 in his personal books of accounts to reduce the value of the share to ₹95. Essentially speaking, he is marking his asset to market.
Let us take an example at a company’s level. Suppose a company has a building which is recorded at a value of ₹10 crore. However, due to slowdown in the market, its current market value drops to ₹9.2 crore. Hence, the company will have to reduce its value in the books by ₹80 lakh to reflect the true value of its building. Now that we have learnt mark to market’s meaning, let us talk about its importance.
Additional Read: What is Demat Account: Importance, Features and Types
Importance of Mark to Market (MTM)
These are the benefits of mark to market:
Real-time Valuation: Market to market helps us see the real valuation of an asset or liability. If not for mark to market, neither the individual nor the company will know the real or true value of their assets in the examples provided above. Without knowing the true value, they will not know the correct value of their net-worth, which can be a difficult situation.
Measure of Performance: Whether you are an individual or a company, you need to mark to market your assets and liabilities to measure how they perform. If you keep on valuing your assets and liabilities at outdated book values, then you will never know how they have performed in the real market. Hence, mark to market is an effective measure of performance.
Regulatory Compliance: Often, regulators in financial markets use the MTM approach to ensure that people who are taking positions meet the margin requirements by maintaining sufficient capital. Besides, many kinds of financial instruments need to be marked to market to find their real value to protect investors and ensure financial stability.
Risk Management: MTM can help in risk management by enabling investors to know the real value of their assets or liabilities. Suppose an investor buys a stock, he can use a stop-loss order and parallelly keep an eye on the stock’s price (thereby using mark-to-market). If the stock’s price starts falling rapidly, the stop-loss order and the fact that he is tracking the market will ensure that his losses are limited. Otherwise, his losses can increase like anything when the stock’s price falls by a huge margin.
Transparency: When a company marks to market all its assets and liabilities that are required to be valued at current value by regulations, it provides a clear picture of its financial position to all the stakeholders involved, including shareholders, creditors, customers, and regulators. It results in a high degree of transparency, as the stakeholders get up-to-date information without having to rely on outdated book values of those assets and liabilities.
Portfolio Monitoring: Unless you mark your positions to market, you will not be able to monitor the profits or losses on your portfolio. Hence, portfolio monitoring is one of the main benefits of MTM. When you mark your positions regularly, it also helps you decide which positions to hold on to and which positions to liquidate. Hence, MTM plays an important role in decision-making as well.
How Does Mark to Market Work in India?
In India, the mark to market mechanism requires that profits are credited and losses are debited from a trader’s account every day from the moment he takes a position in the market. Due to this, the value of margin in a trader’s account changes daily. When due to adverse movements in the market, the initial margin becomes lesser than the maintenance margin, a broker may issue a margin call.
To understand how mark to market works in India, let us take an example of a trader who buys a futures contract on a stock called X on Monday when it is trading at ₹2,000.
Let us say that each futures contract represents 200 shares of X. Assume that a trader has to provide an initial margin of ₹100,000 for this futures contract, while the maintenance margin is ₹80,000.
Now, let us say that the price of the futures contract moves to ₹2,100 on Tuesday, ₹1,950 on Wednesday, and ₹1,850 on Thursday. The following table shows how the changing price will have impact on the profits and losses of the trader.
Notice that the margin will fall to ₹70,000 by the end of Thursday, which means it will be lower than the maintenance margin of ₹80,000. Hence, the broker will issue a margin call by the end of Thursday. As a result, either the trader will have to deposit more funds in his margin account or the broker can liquidate 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
|
Conclusion
Whether you are about to open a trading account or are a seasoned trader, you should understand the concept of MTM well. You must also understand various types of mark to market. In other words, you should know how it works at an individual’s level and at a company’s level. By knowing this concept well, you will be able to appreciate how the real market value of a position can differ from its book value and how that can impact your trading strategy.
Disclaimer: Investments in the securities market are subject to market risk, read all related documents carefully before investing.
This content is for educational purposes only. Securities quoted are exemplary and not recommendatory.
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