Mark to market

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In its broadest sense, mark-to-market is the process whereby the price or value of a security, futures contract, portfolio or account is revalued daily using current prices to determine profit/loss and, therefore, variation margin.

Futures trading uses mark-to-market accounting, which requires assets to be valued at current market prices. At the end of the trading day, the exchange settles the current price for each contract, and the account is credited or debited based on that day's gains or losses. Trading losses are not allowed to accumulate from day to day.

In the stock market, by contrast, price settlement can span three days, known as T+3.

Futures traders need to make an initial margin deposit with their broker. This is not a down payment, but a good-faith deposit to assure that the account has enough money to cover any losses incurred while trading.

Minimum margins are based on a percentage of a contract’s underlying value, and are determined by the futures exchange and by the brokerage firm. Margins are a small fraction of the total value of the futures contract, typically between about 3 percent and 15 percent. The amount required for a futures margin differs by the product’s underlying value and also by the amount of current volatility in that market. The greater the volatility, normally the larger the initial margin required for deposit. This ensures that the margin will be adequate to cover the maximum loss that could be incurred in a single day.

If a futures account drops to a certain level, the trader must add margin money to bring the account back up to the original margin amount -- this is known as a "maintenance margin." Until that maintenance margin is satisfied, the trader is not allowed to continue trading. Traders can take profits above the initial margin level but must always maintain the minimum margin required by the brokerage firm.

Mark to market is an important feature of futures, as it is a daily accounting of profits and losses. A trader who makes a profit today will see the money deposited in his/her account before the next morning. If the trader loses money, the loss will be deducted from the account before trading begins that next morning.

In the wake of the financial meltdown that began in late 2007, business groups pleaded with the SEC and the Financial Accounting Standards Board to suspend or amend the mark to market rule so that banks would be able to account for their hard-to-value assets more favorably. Rumors circulated that the U.S. government might temporarily suspend the rule. In March 2009, however, Reuters reported that the SEC was not planning a suspension of mark to market.[1]


References

  1. SEC won't seek to suspend mark to market. Reuters.