A mark-to-market (or fair value) accounting regime requires that the m

Question

⠀⠀⠀⠀⠀⠀⠀⠀A mark-to-market (or fair value) accounting regime requires that the marketable assets held by a company be accounted for at market value. The rationale for adopting such a rule is to enhance market transparency, thereby facilitating better investment decision-making and more efficient capital allocation. But while mark-to-market improves the information available to market participants, it also has undesirable systemic implications in times of financial turbulence.

⠀⠀⠀⠀⠀⠀⠀⠀Mark-to-market can amplify the effects of financial distress in a couple of important ways. First, when liquidity shortages and/or capital requirements force companies to sell illiquid assets, the market value of these assets diminishes. Under a mark-to-market regime, this loss of value impacts the balance sheets of all other owners of these assets as well. These mark-to-market losses can generate further contagion insofar as they lead to further forced sales and further reductions of the market value of illiquid assets.

⠀⠀⠀⠀⠀⠀⠀⠀Second, mark-to-market can result in direct balance-sheet transmission of losses. In networks of financially interconnected agents, where someone's assets are someone else's liabilities, mark-to-market can trigger a domino effect of debt deflation even in the absence of defaults. When a financial operator suffers a loss of value of some of its assets, this loss diminishes the market value of its outstanding debt. Then the holders of such debt, insofar as they mark it to market, suffer a loss that worsens their own balance sheets and shrinks the market value of their own outstanding debt. In this scenario, the transmission of losses from debt-issuers to debt-holders does not require the occurrence of defaults, as mark-to-market turns expected losses (embedded in market prices) into accounted losses.

⠀⠀⠀⠀⠀⠀⠀⠀Conversely, under a historical cost accounting regime, the transmission of losses from an agent towards his creditors occurs only in case of default. Because of this simple difference, the flow of losses that crosses a financial network, induced by an exogenous negative shock, is larger with mark-to-market accounting, exposing the financial network to elevated systemic risk.   1 
1. According to the passage, a mark-to-market (or fair value) accounting regime requires that the marketable assets held by a company be accounted for at market value, and mark-to-market improves the information available to market participants. Which of the following best describes the relationship between the two highlighted statements?

A. The first describes a principle; the second explains the rationale underlying this principle.
B. The first makes a generalization; the second is a counterexample to this generalization.
C. The first contains an assertion that the writer accepts; the second disputes the accuracy of this assertion.
D. The first introduces a policy; the second questions the effectiveness of this policy.
E. The first contains an assertion that the writer rejects; the second is a faulty inference drawn from this assertion.

2 
2. Each option contains a pair of answers separated by a semicolon. Which pair of answers best completes the following sentence?

In the second paragraph, the author focuses on loss transmission involving ________, while in the third paragraph the writer focuses on loss transmission involving _______.

A. sales of liquid assets; sales of illiquid assets
B. forced sales of jointly owned assets; ownership of debt issued by another company
C. a historical accounting regime; a mark-to-market accounting regime
D. systemic risks; non-systemic risks
E. assets not included on a company’s balance sheet; losses that are expected based on current market prices but not yet accounted for

3 
3. Which of the following best describes the purpose of the fourth paragraph?

A. To demonstrate that mark-to-market accounting is a superior alternative for a financial system that is strong enough to withstand elevated systemic risk.
B. To discuss various methods for minimizing systemic risk under mark-to-market accounting.
C. To provide a benchmark for evaluating the effects of mark-to-marking accounting.
D. To acknowledge that any accounting regime has certain pros and cons.
E. To explain why financial regulators in some countries discontinued the use of historical cost accounting standards.

4 
4. The passage mentions all of the following as possible advantages of mark-to-market accounting EXCEPT:

A. Assisting investment decision-making.
B. Encouraging more productive allocation of capital.
C. Providing better information to market participants.
D. Stabilizing markets for illiquid assets.
E. Improving market transparency.

5 
5. The passage implies that

A. exogenous shocks are more likely to occur in jurisdictions that use historical cost accounting.
B. exogenous shocks are more likely to occur in jurisdictions that use mark-to-market accounting.
C. systemic risk is greater under a historical cost accounting regime than under a mark-to-market accounting regime.
D. under a historical cost accounting regime, when a debtor is in serious financial distress but has not yet defaulted, the debtor’s losses are sometimes transmitted to creditors.
E. historical cost accounting does not treat expected losses as accounted losses.

sayan640 · Answer

MartyMurray   KarishmaB  Can you please discuss this RC ?

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sayan640 · Answer

Not sure why the OA s are NOT being visible.
Can you please help ?
 Sajjad1994   GMATNinja

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bb · Answer

I can add the OA's into the question (you can also edit it I believe).
The question is a bit odd as it has a blank consisting of 2 parts in the second question. I have never seen an RC like that.

sayan640 · Answer

bb  Can you please re format the question so that others can see the OAs ?

Bunuel · Answer

Added the OA's. Hope al is good now.

haashibhansali · Answer

1. According to the passage, a mark-to-market (or fair value) accounting regime requires that the marketable assets held by a company be accounted for at market value, and mark-to-market improves the information available to market participants. Which of the following best describes the relationship between the two highlighted statements?

A. The first describes a principle; the second explains the rationale underlying this principle.- clearly first part is a principle and second part is the thought process hence the answer  
 B. The first makes a generalization; the second is a counterexample to this generalization.- its not a generalisation its an actual principle/strategy  
 C. The first contains an assertion that the writer accepts; the second disputes the accuracy of this assertion.-  incorrect    
 D. The first introduces a policy; the second questions the effectiveness of this policy.- mark to market is not a policy  
 E. The first contains an assertion that the writer rejects; the second is a faulty inference drawn from this assertion.- does not explain this relationship

haashibhansali · Answer

3. Which of the following best describes the purpose of the fourth paragraph?

A. To demonstrate that mark-to-market accounting is a superior alternative for a financial system that is strong enough to withstand elevated systemic risk.-   passage does not quantify any strategy over other hence incorrect   
 B. To discuss various methods for minimizing systemic risk under mark-to-market accounting.  no method is discussed , hence incorrect   
 C. To provide a benchmark for evaluating the effects of mark-to-marking accounting.-  correct , passage talks about historical like a comparison/benchmark to mark to market , hence answer  
 D. To acknowledge that any accounting regime has certain pros and cons.  pros and cons of only mark to market is discussed not historical , hence incorrect   
 E. To explain why financial regulators in some countries discontinued the use of historical cost accounting standards.- incorrect no details of this given

thevi · Answer

Why is the answer to Q5 not B

A mark-to-market (or fair value) accounting regime requires that the m

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A mark-to-market (or fair value) accounting regime requires that the m

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