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Waseem Alim

Mark-to-market is an accounting practice by which companies value and report their assets, especially financial instruments, at market price. Market price basically refers to the price at which the asset, or a similar asset, is trading at in a public exchange. The concept is derived from the accounting principle of prudence.

This is different from mark-to-model where the asset value is based on management's assumptions.

Mark-to-market accounting is typically used for Level 1 and Level 2 assets. In the case of Level 1 assets there is typically an actively traded exchange for that asset, e.g. for most stocks, a market price can be found easily. Level 2 assets are not traded actively, but it is possible to determine their prices based on prices of other similar assets; e.g. bonds of comparable quality. On the other hand, mark-to-market accounting is not used for Level 3 assets since they cannot be reasonably compared to any market price.

Mark-to-market accounting is always used in valuing futures contracts. The final value of a contract is not know till its expiration, but at the end of each day the value of the contract is adjusted to reflect the closing price for that date.

Numerical Example

Suppose an investor owns 100 shares of a stock purchased for $40 per share. However, that stock has increased in price, now trades at $60. The "mark-to-market" value of the shares is equal to (100 shares × $60), or $6,000, whereas the book value might (depending on the accounting principles used) be $4,000, based on the price paid for those stocks.

Similarly, if the stock falls to $30, the mark-to-market value is $3,000. In this case, the investor has lost $1,000 of the original investment. If the stock was purchased on margin, this might trigger a margin call and the investor would have to come up with an amount sufficient to meet the margin requirements for his account.

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