MARKING TO MARKET IN DERIVATIVES MARKETS – Dr. G. Y. Vishwanath

22nd January 2026

Medium Link : https://medium.com/@gyvishwanath/marking-to-market-in-derivatives-markets-89e4639f97ee

Course Relevance

This caselet is designed for the following PGDM / MBA courses:

• Investment Management:
  Covers investments, scams and risk,
• Financial Derivatives : applies finance concepts to futures, forwards and swaps. How futures markets are risk managed?
  
  

Academic Concepts

• This caselet draws on multiple applications of finance knowledge in MTM concepts and the calculations involved.
• It talks about the risk of manipulation of derivative prices for maintaining MTM.
• It talks about due diligence by the authorities.

Marking to Market (daily settlement) Marking to market refers to the daily settling of gains and losses due to changes in the market value of the security. For financial derivative instruments, such as futures contracts, use marking to market. If the value of the security goes up on a given trading day, the trader who bought the security (the long position) collects money – equal to the security’s change in value – from the trader who sold the security (the short position). Conversely, if the value of the security goes down on a given trading day, the trader who sold the security collects money from the trader who bought the security. The money is equal to the security’s change in value.

The value of the security at maturity does not change as a result of these daily price fluctuations. However, the parties involved in the contract pay losses and collect gains at the end of each trading day. Arrange futures contracts using borrowed money via a clearinghouse. At the end of each trading day, the clearinghouse settles the difference in the value of the contract. They do this by adjusting the margin posted by the trading counterparties. The margin is also the collateral.

Margin system In futures contract, the clearing house undertakes the default risk. To protect itself from this risk, the clearing house requires the participants to keep margin money. Thus margins are amounts required to be paid by dealers in respect of their futures position to ensure that both parties will perform their contract obligations. Types of margin 1. Initial Margin Initial Margin is the capital sum which an investor needs to park with his broker as a down payment in its account to initiate trades. This acts as a collateral. An investorcan offer cash and securities or other collateral like open ended Mutual fund as collateral to enter into a trade. In most cases, especially for equity securities, the initial margin requirement is 30 % or exchange defined margin whichever is higher, but this may vary. And yes, both buyers and sellers must put up a payment to enter into a trade. 2. Maintenance Margin After purchasing the stocks, a minimum balance called as maintenance margin needs to be parked with the broker. In case the margin drops below the limit, your broker will make a margin call and can also liquidate the position if you do not make up for the requirement amount. Maintenance Margin varies between 20-30% subject to minimum exchange charged margin and may change depending on a position an investor wants to hold in a stock market. 3. Variation Margin Variation margin is the additional amount of cash you are required to deposit in your trading account to bring it up to the initial margin after you have incurred sufficient losses to bring it below the “Maintenance Margin”. Variation Margin = Initial Margin – Margin Balance.

Stock Futures Stock Futures are financial contracts where the underlying asset is an individual stock. Stock Future contract is an agreement to buy or sell a specified quantity of underlying equity share for a future date at a price agreed upon between the buyer and seller. The contracts have standardized specifications like market lot, expiry day, unit of price quotation, tick size and method of settlement. Currency futures Currency futures are a exchange-traded futures contract that specify the price in one currency at which another currency can be bought or sold at a future date. Currency futures contracts are legally binding and counterparties that are still holding the contracts on the expiration date must deliver the currency amount at the specified price on the specified delivery date. Currency futures can be used to hedge other trades or currency risks, or to speculate on price movements in currencies.

Teaching note : This is a contemporary topic of interest for the students of investments and finance. Students need to know the happenings in the financial markets and in this regard, we are asking the students to understand this concept as it is the basic knowledge required in trading in futures. Understanding this would cover the MTM applications in different types of futures markets and how the markets can be dangerous without the MTM and risk management tools.. Hence our students and traders should be aware of these applications to better understand the market.

Teaching Note :

This topic is relevant for the security analysis,nternational Finance and derivatives course studied by the PGDM2 students. This covers what is Marking to market and how to use it  and prevent bigger losses for the firms and investors. As we have discussed this knowledge will help in reducing the risk and making use of opportunities  which arise in the markets time to time.

Learning Objectives

After engaging with this caselet, students will be able to:

• Analyze how the MTM concept works applied for risk management.
• How to calculate MTM for volatile markets.
• Evaluate the risk and return of strategies keeping mtm positioning in mind.

Key Discussion Points

1. Importance of MTM in preventing huge losses.
2. How to reduce risk in trading and how to educate investors in using these concepst.

Discussion Questions :

1. Explain the concept of MTM and how its computed?
2. How brokers use MTM for risk management?

References :

1. Francis, S. (2011). How to ‘mark-to-market’when there is no market. Journal of Derivatives & Hedge Funds, 17(2), 122-132.Figlewski, S. (1984). “Hedging Performance and Basis Risk in Stock Index Futures.” The Journal of Finance, 39(3), 657-669.
2. Francis, S. (2011). How to ‘mark-to-market’when there is no market. Journal of Derivatives & Hedge Funds, 17(2), 122-132.
3. Chukwuogor-Ndu, C. (2006). Stock market returns analysis, day-of-the-week effect, volatility of returns: Evidence from European financial markets 1997-2004. International Research Journal of Finance and Economics, 1(1), 112-124.

4.    Madhumathi. R & Ranganatham. M (2012).

“Derivatives and Risk Management.”