Mark-to-Market

So what is a mark-to-market book? Well, that simply means the book is "marked" or re-valued to the market prices every day. That gives a pretty good sense of where the book can be liquidated on any given day. Accrual, in contrast, is an accounting thing that pretty much means you get to book it at transaction value plus cash-flows. Thus the daily price moves do not matter as much as the daily cash-flows.

Alright, great, so what's this mean in practice?

Well, a mark-to-market book will always be changing value. Usually trading books and hedge funds are marked-to-market. All liquid products and futures are marked-to-market. It usually means you have to fund the positions via some funding rate because you're probably not just putting cash up directly. You may have margin calls on the marked positions. For exchange traded securities the exchange closes are used as daily marks. For illiquid assets (i.e. those illiquid sub-prime mortgage securities that everyone's whining about), you often mark to market as well (by getting dealer prices on a daily basis, for example). While you usually have a good idea of liquidation value through this method, during a fire-sale of a portfolio the actual liquidation value may be considerably lower, especially for the less liquid stuff.

An accrual book does not need to worry about a lot of the above. The assumption is that the assets being held are not held for risky reasons, they are being held for accounting reasons. Thus it is less likely the assets will need to be quickly liquidated. Most of these types of accounts are "real money" accounts such as bank portfolios and insurance portfolios where people are likely just trying to match their liabilities (i.e. interest payments and insurance payments) with their assets (whatever they're buying in the market). These accounts tend to hold stuff longer, make bigger moves and not be as concerned about the daily PnL of the book.

Looking at a more micro perspective, what does this mean for the people who work there? A mark-to-market book must be sensitive to the daily changes in risk and PnL. The traders and portfolio managers will obsessively mark to the exact market closes and track their PnL and daily variation. On an accrual book, the long term view is the most important. Traders and portfolio managers will make sure their macro view is correct and their liabilities are hedged for the long term. The mark-to-market sensitivity can take many good trades out due to "stop-losses." Then again, mark-to-market sensitivity can make one more "in-tune" to the market as well.

The ability and necessity for different institutions to account for their securities as accrual or mark-to-market greatly effects how they trade as well as how they enter into positions. Sometimes what might be best for the institution will not be best for the accounting (and sadly, the accounting often wins). Accounting, while irrelevant to a wholly owned private company, can mean the world to public companies or hedge funds.