Mark to model
In normal circumstances, securities such as shares or bonds are valued by using market prices: this valuation method is called 'mark to market'.
In normal circumstances, securities such as shares or bonds are valued by using market prices: a share in Acme Widgets sold for £1.50, so your holding of Acme Widgets in your portfolio should be valued at that price. This valuation method is called 'mark to market'.
But in situations where the securities are rarely traded and there are no recent reference prices, valuing your holdings may be more difficult. So these investments may be valued in alternatives ways that use internal pricing models or assumptions, a process known as "mark to model".
Typically the type of assets that are valued using this technique are complex derivatives contracts and securitised debt instruments. The sub-prime mortgage crisis in 2007 highlighted the problem with mark to model, in that valuations based on models and assumptions can be wildly incorrect: default rates proved higher than expected and holders of these securities ultimately had to write off tens of billions of dollars.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
A second problem is that even if valuations are accurate, it may be difficult to sell illiquid securities quickly at a fair price, so marked-to-model portfolios can give a false impression of how much can be raised in a fast sale.
Sign up to Money Morning
Our team, led by award winning editors, is dedicated to delivering you the top news, analysis, and guides to help you manage your money, grow your investments and build wealth.
-
What the Employment Rights Bill means for your workplace rights
New workplace reforms are set to give employees new rights to benefits and flexible working
By Marc Shoffman Published
-
GSK share price surges after $2.2bn Zantac drug settlement
GSK has settled lawsuits in the US that alleged the drugmaker’s now-discontinued heartburn drug Zantac triggered cancer
By Chris Newlands Published