Mark to market

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In economics, mark to market is the act of assigning a value to a position held in a tradeable financial instrument based on the current market price for that instrument.

History and development

The practice of mark to market as an accounting device first developed among traders in 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, leaves a sum of 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 him back part of the margin. On the other hand, if he is on the losing side, he may face a "margin call," and have to choose between putting up more money or liquidating part of his position.

Other sorts of derivatives, though, aren't traded through exchanges -- they are traded through customized contracts, or "over the counter". During their early development, such over-the-counter 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.

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 $50 per share, then the "mark to market" value of the investor's shares is equal to (100 shares * $50), or $5000.

See also

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