For those who are interested in futures trading or who trade stocks with a margin account, it is important to understand how mark to market works.
This includes knowing the impact it can have on your returns, as well as the possibility of being liable to a margin call.
Mutual funds are daily marked to market at the close of the day. This allows investors to gain a better understanding of the fund’s Net Asset Value. We’ll take a look at what mark to market is, how it works and what effect it has on investments.
What Is Mark To Market?
Mark to market is the process of documenting the value or price of a stock, security or portfolio so that it reflects the current market value as opposed to its book value. The book value of an asset is the value of an item after accounting for depreciation.
It is typically done with futures accounts so that margin requirements are met. If margin accounts, also known as brokerage accounts, fall below a required level, then a trader can face a margin call. This is a requirement for them to add additional funds.
Mark to market is also used for mutual funds daily at the close of market so investors better understand the Net Asset Value of a fund. This is the total value of assets in the fund minus its liabilities.
Understanding How Mark To Market Works
Mark to market works by adjusting an asset’s value according to the current market conditions. This is to determine the price that the asset could achieve if it were to be sold immediately.
In the stock market, determining the mark to market value of securities is done by looking at market performance and volatility. This is done by examining the current trading price of a stock and making adjustments to the value based on the price at the end of the trading day.
However, market volatility may mean that the mark to market value of an asset does not reflect its true value. This can happen when there are unfavorable market conditions, such as during a financial crisis.
New guidelines following the 2008 financial crisis means however that a valuation can be based on a price that would be gained in an orderly market rather than in a forced liquidation.
Mark To Market In Investing
Mark to market is used in investing to calculate the current value of portfolios, securities or trading accounts (see also ‘How To Calculate Gross Investment‘). It is most commonly used when investors are using margin accounts to trade in futures or other securities.
Futures are financial contracts that are agreed upon between two or more parties that assume or derive their value from an underlying asset or group of assets. A margin account uses money that is borrowed from a brokerage to increase purchasing power.
In order to continue trading, it is important to meet margin requirements and understanding mark to market is important in this respect. Commonly, an investor will need 50% of the securities purchased in marginable securities or deposit cash in the margin account.
This is to maintain the margin, which is the amount of money in the account to continue trading. In futures trading, mark to market is utilized at the end of the day to price contracts. Based on the closing price, adjustments are made to show the day’s profit or loss.
These adjustments in turn affect a futures account’s cash balance, which can impact on an investor’s ability to meet margin requirements.
Futures Contracts & Mark To Market
A futures contract is typically held between two parties, one who holds a long position and one who holds a short term position. The long trader is termed ‘bullish’ and the short trader ‘bearish’ reflecting their different positions.
If the value of a contract falls, then the account of the bullish trader will be debited and the bearish account will be credited due to the adjustment in value. The trader in the short position will benefit more than the long trader from a decline in the value of a contract.
However, the daily mark to market settlements for future contracts continues until one of the traders closes their position.
What Assets Are Marked To Market?
The kind of assets that are marked to market are those which are bought and sold relatively quickly for cash. These are called marketable securities and include futures, stocks and mutual funds.
It is possible to establish a fair market value for these securities based on the current conditions of the market. Tangible and intangible assets cannot be valued with the mark to market method.
Fixed or tangible assets are valued using historical cost accounting. Intangible assets such as goodwill, reputation or intellectual property have to be valued with different methods.
What Are Mark To Market Losses?
In the event that the value of an asset falls from one day to the next, it is said to have experienced a mark to market loss. However, it is unrealized as it only represents a change in the valuation of the asset and not any loss of capital associated with the asset’s sale.
The loss occurs when the value of a security or asset is adjusted to reflect the change in its market value. During financial crises, it is difficult to realistically assess the fair market value of a security or asset.
In 1929 the banks were forced to devalue assets based on mark to marketing rules and this accentuated what may have been a temporary financial crisis into the Great Depression. New guidelines post 2008 as discussed above ensure that this can no longer happen.
Mark to market is an important tool, especially for futures trading. It is also important to understand for those who are trading stocks with a margin account, as maintaining margin requirements is essential in order for an investor to keep trading.
We hope this guide to mark to market has been useful.
If you enjoyed this article, you might enjoy our post on ‘What Is Float In Stocks?‘.
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