The stock market changes every second due to constant trades taking place between the buyers and the sellers. It becomes difficult to evaluate the fair market value for the investors. Mark to Market (MTM) is used in many cases, such as for calculating the NAV of mutual funds. It is very helpful in deciding in case of buy or redeem units.
This article will give deep insights into MTM and its working procedure. For better knowledge pros and cons are also listed.
Mark to Market Meaning
Mark to Market is the process of recording an asset or liability’s value using its current market value as opposed to its purchase price or previous price. This enables both individuals and businesses to modify the value of financial instruments in response to daily price changes.
Key Features:
- Indicates fair market value.
- Frequently utilised in accounting, mutual funds, and futures trading.
- Depending on the needs, it can be completed every day, every month, or every three months.
- Helps to increase transparency and accuracy.
How Does MTM Work in Different Financial Areas?
Let us see the working of MTM for accurate valuation and effective decision making:
1. Trading in Futures and Derivatives
MTM is used to settle gains and losses on a daily basis in trading futures and derivatives. The exchange uses the contract’s closing price to determine the MTM amount at the conclusion of each trading day.
Procedure:
- The position of each trader is marked by the daily settlement price.
- The trader’s margin account is credited with the profit if the value rises.
- The associated loss is debited if it falls.
- The open positions represent current market exposure.
2. Calculating NAV and Mutual Funds
MTM is used daily by mutual funds, particularly debt and equity funds, to determine the fair value of their underlying securities. This is essential for calculating the fund’s Net Asset Value (NAV), which is its price per unit.
NAV = (Market value of assets – Liabilities) / Number of outstanding units
Procedure:
- The market closing price is used to revalue the securities portfolio, which includes stocks, bonds, and other assets.
- The NAV will help in making decisions about buying or redeeming units.
3. Balance sheet reporting and corporate accounting
MTM is used by businesses that deal with assets or financial instruments such as marketable securities, commodities, or foreign exchange derivatives in order to provide accurate financial reporting.
Typical Assets with MTM:
- Forward contracts for currencies
- Swaps of interest rates
- Securities of marketable equity
- Holdings of commodities
For instance, a business has Rs. 10 lakhs in foreign exchange contracts. The value is now Rs. 10.5 lakhs as a result of rupee depreciation. Through an MTM adjustment, the ₹50,000 gain is recorded in the income statement.
4. Evaluation of Banking and Loan Collateral
In order to calculate loan-to-value (LTV) ratios, banks frequently use MTM to reevaluate the collateral value of pledged securities (such as stocks or bonds).
Procedure:
- Collateral value rises in response to rising stock prices, which could result in a higher loan amount for the borrower.
- The borrower might have to provide more security (margin call) if stock prices decline.
For instance, you pledge shares valued at Rs. 2 lakhs in exchange for a loan. The bank may request additional securities worth Rs. 50,000.
Pros and Cons of MTM
Let us now understand the pros and cons associated with MTM to gain better insights into it:
Pros:
- Real-time accuracy: Shows how much assets or portfolios are currently worth.
- Risk management: Investors can monitor possible losses or margin shortages with the aid of daily valuation and manage risk.
- Compliance: For reporting in financial institutions and publicly traded companies, regulatory compliance is crucial.
- Transparency: Gives stakeholders insight into financial situations.
Cons:
- Impact of Volatility: Sudden fluctuations in profit or loss can result from frequent price changes.
- Illiquid Assets: When market prices are not available, MTM is challenging to implement.
- Artificial Gains/Losses: The asset’s actual potential may not be reflected in short-term declines.
Bottomline
The conclusion can be drawn that mark-to-market is an essential factor for financial reporting. It helps investors in managing risk, along with providing a fair and accurate judgment of the financial situation. However, decision-making should not be completely based on it, as quick price changes can affect the quality of the decision.
It is important to know these essential terms that have an impact on the trade they make, no matter the asset, like swaps, commodities, etc.
