Mark To Model

A company needs to know how much each one of its assets are worth. It's information the company needs to put on balance sheet, and will impact other financial statements.

But it isn't always easy to figure out the value of certain assets. If the assets don't get sold a lot (meaning a liquid market in similar items doesn't exist that can be used as a reference), the company has to make some guesses.

However, the company can't just make stuff up. It can't say a couch in the break room, which it originally found in a dumpster, is worth $10 million because "there aren't many couches like it." The firm has to use some rational valuation method.

The mark-to-model approach is one of these valuation methods. The company sets up a model to price the asset...a mathematical equation meant to compute its value based on certain market indicators. This process usually works best in cases of complicated financial instruments. As a hedging strategy, the company owns options to buy convertible stock denominated in Iraqi dinar, with a contingent cross-hedge protecting the risk of a decline in the dinar's value versus the euro. These positions would be hard to value and impossible to unwind quickly. So instead, the company creates a model to approximate an appropriate value. It then uses that value for its financial statements...the essence of the mark-to-model approach.