A cap mark is the maximum return on an investment, used to determine financial managers’ pay structure and bonuses. The term comes from flood measurements and is based on an account’s previous peak performance. Using watermarks instead of annual earnings prevents managers from raising extra money on accounts that have lost money overall.
A cap mark is a financial term used to describe the maximum return on an account or investment. Borrowing the term from flood terminology, an upper limit mark is often used to determine the pay structure and bonuses for financial managers. It is important to understand how the theory of the upper limit is applied, to ensure that a financial manager is paid based on actual performance.
The term comes from water flood measurements. A watermark indicated the highest point at which physical evidence, such as staining or a sudden change in vegetation, showed that the water had risen. By finding the highest water mark, the exact height of a previous flood can be determined.
Generally, the term is used to describe an account’s previous peak of high performance. For example, if an investment account was worth $50 United States Dollars (USD) and increased to $75 over the course of a year, the high mark would be $75 USD, and the financial manager could receive performance bonuses for the increase in $25 USD. from the previous standard. In the next year, if the account value dropped to $70 USD, no performance bonus could be awarded.
Using the same example, it is important to note that $75 would still be the high mark even if losses occurred that changed the annual value of the account. Imagine that the value of the account dropped in three years to $60 USD. In the fourth year, if the value increased to $80, the performance bonus would only include the $5 increase from the previous high mark to the new one, not the $20 increase from the lower annual value to the new one. watermark. If losses were factored into the equation, managers could earn higher bonuses by having large losses and marginal gains, rather than through profit alone.
The goal of this bonus strategy is to protect investors by carefully linking the manager’s salary to the investor’s earnings. By doing so, managers have a vested interest in account performance, as their bonuses are tied to their performance. Using watermarks instead of basing bonuses on simple annual earnings prevents managers from raising extra money on accounts that have lost money overall. As long as the account remains below the watermark, you technically haven’t made any money, even if there has been a profit since the previous year. Until you break the maximum mark, the account only offsets losses instead of providing net gains.
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