Margin call explanation

A Quick Explanation of Market-to-Market

I thought I would make a quick post just to explain the misconception of the term ‘market-to-market’ - which is really not a financial term - rather its ‘marked-to-market’. I have gotten a few emails of people asking me what exactly this means and whether I could provide a really simple explanation of this term.

Typically, you see “marked to market” referring to a derivatives position or a margin lending facility. At the end of each trading day, each counter party exchanges the change in the market value of their position in cash. That is, each counter party is required to settle their obligations to ensure a “zero-net-game” exists. So “marking to market” typically occurs at the end of the trading day where an account has fallen below a given threshold and a broker requests from the client, via a margin call, that the client deposits more funds (or at worst, liquidates the account) in order to get the account back within the predefined “ratio limit”. i.e. the ratio limit is the amount a broker will allow for “fluctuations” in the market before instigating a margin call. Typically most brokers set this rate between 5% - 10% of the trade amount. So if you had a $10,000 margin loan set up, and the ratio limit before a margin call was instigated was at 10% - a value drop of more than $1000 would instigate a margin call and you would be required to top up the account.

So really ‘marked-to-market’ means ensuring that the position you are in is “converted to the current market prices” and is a full reflection of the market on any given day at closing.



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