What is Mark to Market (MTM) and How Does It Work

Mark to Market (MTM) is a financial accounting practice used to value assets based on their current market price rather than historical cost. In the context of trading and investing, especially in the futures and options (F&O) segment, MTM is used to calculate daily profits or losses by comparing the open position's current value with its previous value. This dynamic valuation ensures transparency and helps track risk exposure more accurately.

MTM is the process of adjusting the value of an asset or liability to reflect its fair market value on a given day. In trading, it involves recalculating positions at the end of each trading day based on the latest closing price.

This practice is widely applied in:

• Derivatives markets (F&O)
  

• Mutual fund NAVs
  

• Bank and corporate financial statements
  

• Insurance and pension fund asset management
  

MTM ensures that unrealised gains or losses are accounted for daily, instead of only when the position is closed.

In F&O trading, MTM plays a critical role in settling contracts on a daily basis. Unlike equity investments, where gains or losses are realised only when shares are sold, F&O contracts are adjusted daily to reflect market movements.

How it works:

• At the end of each trading day, the contract is revalued based on the closing market price
  

• The difference between the previous day’s value and the current day’s value is calculated
  

• Profit or loss is credited or debited to the trader’s margin account accordingly
  

This ensures that gains and losses are settled every day, avoiding large payment obligations at contract expiry.

The basic formula to calculate MTM in futures trading is:

• MTM = (Closing Price Today - Closing Price Yesterday) × Lot Size × Number of Lots

If the result is positive, it is a gain; if negative, it's a loss. This amount is adjusted daily in the trader’s margin account.

Suppose a trader buys 1 lot of Nifty Futures (lot size = 50) at ₹20,000. On Day 1, the contract closes at ₹20,200.

MTM = (20,200 - 20,000) × 50 = ₹10,000 gain

This ₹10,000 will be credited to the trader’s account. The next day, if the closing price drops to ₹20,100:

MTM = (20,100 - 20,200) × 50 = ₹5,000 loss

This amount will be debited from the margin account. This cycle continues daily until the position is squared off or the contract expires.

Beyond trading, MTM is used by companies, banks, and financial institutions to show asset values in line with market prices.

Examples include:

• Mutual fund Net Asset Value (NAV) calculation
  

• Bond portfolios being valued based on interest rate movements
  

• Derivative contracts on company balance sheets
  

It provides a realistic picture of financial health and helps manage market risks more proactively.

While MTM brings accuracy, it also introduces some risks and challenges:

Market volatility impact

During turbulent periods, MTM can show large fluctuations, even if the investment is fundamentally strong.

Forced liquidations

In F&O, consistent MTM losses can trigger margin calls, forcing traders to close positions prematurely.

Overemphasis on short-term value

For long-term assets, MTM may not reflect the actual intrinsic value, leading to misleading financial reports.

In India, MTM settlement is governed by SEBI regulations and is implemented by stock exchanges like NSE and BSE. Clearing corporations handle daily margin adjustments based on MTM to maintain market integrity.

Key rules include:

• Daily MTM margin collection and settlement
  

• Clearing members and brokers to maintain adequate collateral
  

• Penalties for shortfalls or default on MTM payments
  

This robust framework ensures that counterparty risk in the derivatives market is minimised.

Retail investors should understand MTM when:

• Trading in F&O where margin calls can be triggered by MTM losses
  

• Investing in mutual funds or ETFs where NAV is based on MTM valuation
  

• Evaluating corporate balance sheets which may include MTM adjustments for financial instruments
  

Being aware of how MTM works can help in better financial planning and avoiding surprises due to daily market movements.

Mark to Market (MTM) plays a vital role in modern financial systems by ensuring that valuations reflect current realities. For traders, it determines daily profit or loss and influences margin requirements. For companies and investors, MTM enhances transparency and helps manage risk. While it may add volatility to reported numbers, MTM is a critical tool for maintaining market discipline and accountability.

This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.