Mark-to-market is defined as an accounting tool used to record the value of an asset with respect to its current market price – The market price refers to the price at which the asset is trading at in a public exchange.
The MTM can change the value on either side of a balance sheet, depending on the conditions of the market.
The MTM principle has been part of the Generally Accepted Account Principles (GAAP) in the United States since the early 1990s. The concept is derived from the accounting principle of prudence, which is one of the 7 principles of GAAP. The principle of prudence requires companies to report, on their balance sheet, the value of their assets and liabilities at their least favorable valuation.
An Example of how MTM is calculated
Suppose an investor in Nigerian stocks owns 10,000 shares of Nigerian Breweries shares purchased for N150 per share by 9am on Monday. – The book value amount is (10,000 x N150) = N1,500,000.
However, if the NB stock has increased in price to N160 by 2pm, the Mark-to-market value of his shares will be calculated as follows;
(10,000 shares x N160) = N1,600,000.
The investor also has a MTM gain of N100,000 (N1,600,000 – N1,500,000)
If the price of Nigerian Breweries falls to N140 by 2.30pm on the same day, the MTM becomes (10,000 x N140) = N1,400,000.
This means that the investor has lost N100,000 (N1,500,000 – N1,400,000).
How MTM can affect you as an Investor
Mark to market is important because if you own a stock that holds a large portion of their investments under trading then they stand the risk of mark to market.
For example if you give an Investment company (United Capital) money to manage for you, and United Capital has N5bn worth of investments in say shares that are marked to market, a drop in the value of the All Share Index will result in United Capital losing its investors’ money thus affecting its overall profitability.
If the losses in value of stocks continue to linger for a long term, the company may have to make loss provisions in its statement of accounts, which will in turn affect its share price.
Also, if a bank or an asset management company holds a lot of Nigerian bonds as assets held under trading, a continuous rise in bond yields will take a hit on the market price of the bond.
It is widely agreed by professionals that MTM pricing accurately reflects the fair value of an asset. However, MTM can be an issue in times of uncertainty because the value of assets can vary wildly within seconds. The volatility in the movement of prices is usually not because of fundamental changes in the asset, but due to pressure from buyers and sellers which causes prices to move sporadically.