Marking to market is the practice of updating the value of an asset or portfolio to reflect its current market value rather than its book value. This process ensures that financial statements provide a realistic appraisal of the firm's financial position.
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Marking to market is commonly used in futures and options contracts to ensure that margin requirements are met.
It helps in managing credit risk by adjusting collateral values daily based on market prices.
This practice can lead to significant fluctuations in reported earnings due to changes in market conditions.
It was a key factor during the 2008 financial crisis, where rapid devaluation led to liquidity issues for many firms.
The practice is mandated by accounting standards such as GAAP and IFRS for certain types of assets and liabilities.
Review Questions
Why is marking to market important for managing commodity price risk?
How does marking to market affect a company's financial statements?
Can you explain a scenario where marking to market might result in significant volatility?
Related terms
hedging: A risk management strategy used to offset potential losses or gains that may be incurred by an investment
margin call: A demand by a broker that an investor deposit further cash or securities into their account when its value falls below the required level
futures contract: A legal agreement to buy or sell a particular commodity asset, or security at a predetermined price at a specified time in the future