Location: New York
Author: chartoftheday.com
Date: Wednesday, February 18, 2009
Mark to market is an accounting calculation tracking the current market value of an asset.
Mark to market calculations are typically done daily. Mark to market is based on the current market value of the assets in question (i.e. commodity, security, derivatives, etc.).
Mark to market reflects how much such assets would be sold for if they were put on the market today. Methodologies used in the mark to market calculation are classified on three different levels.
Level 1: market prices for the asset are available and can be used in the mark to market calculation.
Level 2: no market prices are available. Fair value needs to be modeled using observable prices of other assets. The output of this level 2 mark to market model is the mark to market value.
In September 2008, the Securities and Exchange Commission (SEC) clarified that fair value in mark to market should not be based on a distress sale or forced liquidation price (i.e. FAS 157).
Fair value in level 2 mark to market models should only be based on sale prices resulting from an orderly sale.
Level 3: if price quotes or observable price inputs are not available, companies must estimate fair value.
They often rely on proprietary assumptions as input to sophisticated mathematical mark to market models (i.e. black box). However, level 3 mark to market calculations can be controversial due to the lack of transparency.
The advantage of mark to market is that it enables counterparties to track their risk exposure and take appropriate actions (i.e. margin calls, liquidation, etc.) to mitigate counterparty risk. For example, mark to market is used by brokerage firms to calculate margin requirements. Mark to market will help them determine whether or not a margin call is necessary.
The Financial Accounting Standards Board (FASB) guides companies and financial institutions on the requirements that must be followed for proper mark to market reporting by issuing a series of Financial Accounting Standards Board statements known as FAS. Some FAS that are relevant to mark to market calculations are FAS 115, FAS 117, FAS 133, FAS 157, FAS 159. Mark to market is also known as MTM.
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