What is Mark to Market (MTM)?
Mark to Market (MTM) is a valuation method widely used in finance to assess the current market value of assets and liabilities. Unlike historical cost accounting, which records the original purchase price, MTM reflects real-time changes in the value of assets based on prevailing market conditions. This ensures that financial records and portfolios stay aligned with the actual market environment.
In the context of the Indian stock market, MTM plays a critical role in evaluating trading positions, particularly in segments like derivatives, equities, and commodities. It helps traders, investors, and financial institutions understand their real-time profit or loss and manage their positions more effectively.
How Does Mark to Market (MTM) Work in the Indian Stock Market?
In the Indian stock market, MTM is particularly relevant in the Futures and Options (F&O) segment and for intraday trading. Here is how it works:
1. Daily Settlement in Derivatives
In derivatives trading, such as futures contracts, MTM is calculated daily to adjust the trader’s margin account. This process is known as “marking to market.”
- If the market price of a futures contract increases, the buyer’s account is credited with the profit, while the seller’s account is debited with the loss.
- Conversely, if the market price decreases, the seller gains and the buyer’s account is debited.
For example, if you hold a futures contract for Nifty 50 at 18,000 and the index rises to 18,100, your account will be credited with the profit corresponding to the 100-point rise.
2. Equity Trading
In stock trading, the MTM value represents the difference between the current market price and the purchase price of the stock. This helps investors track their portfolio’s real-time performance.
For instance, if you purchase 100 shares of a company at ₹500 each and the market price rises to ₹600, your MTM profit would be:
- ₹600 – ₹500 = ₹100 per share.
- Total MTM Profit: 100 shares × ₹100 = ₹10,000.
3. Commodities and Currency Markets
MTM is also applied in commodity and currency markets in India. For example, gold futures or USD-INR futures contracts are marked to market daily, ensuring accurate valuation of open positions.
Examples of Mark to Market (MTM) in the Indian Context
Example 1: Futures Contract
Suppose you enter a futures contract to buy Reliance Industries at ₹2500 per share. If the market price rises to ₹2600 by the end of the trading day, your MTM profit is:
- (₹2600 – ₹2500) × Contract Size.
- For a contract size of 500 shares, the MTM profit would be ₹50,000.
Example 2: Intraday Trading
An intraday trader buys 1,000 shares of TCS at ₹3100 each and sells them at ₹3200 within the same day. The MTM profit is:
- (₹3200 – ₹3100) × 1,000 = ₹100,000.
Example 3: Mutual Funds with MTM
In the mutual fund industry, MTM is used to calculate the Net Asset Value (NAV) of a fund. The NAV reflects the current market value of the underlying assets, ensuring that investors see the true value of their investments.
Advantages of Mark to Market (MTM) in the Indian Stock Market
- Real-Time Valuation MTM helps traders and investors know the exact value of their portfolios or positions based on current market prices. This is crucial in fast-moving markets like India.
- Transparency By marking assets to market, financial statements become more transparent, reflecting true market conditions rather than outdated historical costs.
- Risk Management MTM ensures that traders and brokers manage risk effectively by adjusting margins daily. This prevents defaults in volatile markets.
- Accurate Portfolio Tracking For retail investors, MTM provides an accurate snapshot of the performance of their investments, enabling better decision-making.
- Regulatory Compliance In India, regulatory bodies like SEBI mandate MTM practices to ensure fairness and accuracy in financial reporting, especially in trading and institutional portfolios.
Disadvantages of Mark to Market (MTM) in the Indian Stock Market
- Impact of Market Volatility In a volatile market, frequent fluctuations in asset prices can lead to significant MTM adjustments. This might cause unnecessary panic or exuberance among investors.
- Unrealized Gains and Losses MTM often shows paper profits or losses, which may not materialize. Investors might overreact to these numbers without considering long-term potential.
- Liquidity Challenges In derivatives trading, daily MTM settlements require traders to maintain sufficient liquidity. If losses accumulate, traders may need to infuse additional funds, leading to financial strain.
- Distortion of Financial Health For businesses, MTM adjustments can make financial statements appear volatile, even if the underlying operations are stable.
- Complexity for Retail Investors Many retail investors in India find the concept of MTM challenging to understand, particularly when dealing with derivatives or leveraged trades.
Conclusion
Mark to Market (MTM) is an indispensable practice in the Indian stock market, ensuring that valuations remain accurate and reflective of real-time conditions. While it offers transparency, real-time risk assessment, and compliance with regulations, it also has its challenges, especially during periods of high volatility.
For traders, MTM is essential for managing margins and understanding daily profit and loss. For long-term investors, it provides an updated view of their portfolio’s value. However, it is crucial to balance MTM adjustments with a broader understanding of market dynamics and investment objectives.
By using MTM effectively and complementing it with other analytical tools, participants in the Indian stock market can make more informed and confident financial decisions.
