Could you explain the concept of end-of-day "marking" in the context of fixed income securities?

Question

I'd like to understand what "marking" actually means. What would happen if a trader marked a price that was too high or too low?

Answer 1

Bonds do not trade every day. However, mutual funds need prices for those bonds so they can report their Net Present Value. Also, some brokerage firms like Lehman and Merrill report returns on a bond index, so need prices for all of the bonds in the index -- even if they didn't trade.

What these firms do is send some kid right out of school down to the trading floor to get prices from the traders. These are not firm prices -- they are "indications." There is no incentive for traders to give the correct price -- so they can be considered ballpark figures at best.

The trader usually keeps a spread over treasuries. For example, he might thing that a certain bond should trade with a yield that is 1.2% above the yield of the ten-year treasury rate.

Traders often mark the bonds too high or too low. This is because they don't update the spread unless something ahppens. However, they eventually will correct the spread (usually when they have to give a firm bid for it). The effect is that you may get mispricings on a day yo day basis, but in the long run the returns of the index -- or mutual fund -- will be pretty close to the truth.

Answer 2

Marking merely means recording the current price. Since the prices change throughout the trading day, to evaluate trading performance on a day to day basis it is necessary to choose a particular time of day at which to record the price of the security on that day. This is normally done at the beginning of the day or the end of the day. End of day marking simply means recording the current price of the security at the close of trading. If a trader marks a price which is too high or too low it merely affects how the medium-term performance of that particular stock looks the next day. After a day it would be corrected.