Over-the-counter market (O.T.C.)

The over-the-counter (O.T.C.) market is a decentralized market where securities, currencies, and other financial instruments are traded directly between parties without a central exchange.
Updated: Jun 27, 2024

3 key takeaways:

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  • The O.T.C. market involves direct trading of financial instruments between two parties, typically via dealer networks.
  • It is characterized by flexibility, as participants can negotiate terms directly, often leading to customized agreements.
  • The O.T.C. market is essential for trading securities not listed on formal exchanges, such as certain stocks, bonds, and derivatives.

What is the over-the-counter (O.T.C.) market?

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The over-the-counter (O.T.C.) market refers to a decentralized market where trading occurs directly between parties without the supervision of a formal exchange. Transactions are typically conducted through a network of dealers or brokers who negotiate prices directly. This market is crucial for trading financial instruments that are not listed on traditional exchanges, such as certain stocks, bonds, derivatives, and currencies.

Unlike centralized exchanges, the O.T.C. market does not have a physical location. Instead, it relies on electronic networks and phone-based trading to facilitate transactions. This setup provides greater flexibility and allows for a wider range of financial instruments to be traded.

How does the O.T.C. market work?

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  • Direct negotiation: Buyers and sellers negotiate terms directly, often with the help of dealers or brokers who facilitate the transactions.
  • Dealer networks: Dealers act as market makers by quoting prices at which they are willing to buy and sell securities. They earn a profit from the spread between the bid and ask prices.
  • Custom agreements: The O.T.C. market allows for the creation of customized financial agreements that may not meet the standard requirements of centralized exchanges.

For example, a company might issue bonds that are not listed on an exchange. Investors can buy these bonds in the O.T.C. market by negotiating directly with the issuer or through a broker.

Advantages of the O.T.C. market

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  • Flexibility: Participants can negotiate terms and customize agreements to suit their specific needs.
  • Access to a wider range of securities: The O.T.C. market includes many financial instruments that are not available on formal exchanges.
  • Less regulation: The market operates with fewer regulations compared to centralized exchanges, providing more freedom for participants.

Disadvantages of the O.T.C. market

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  • Lack of transparency: Since transactions are private, there is less transparency regarding prices and trading volumes compared to centralized exchanges.
  • Higher risk: The reduced regulation and lack of standardization can increase the risk of default and fraud.
  • Liquidity issues: Some O.T.C. securities may have lower liquidity, making it harder to buy or sell them quickly without affecting the price.

For instance, trading a less-known company’s stock in the O.T.C. market may involve higher risks and less price transparency compared to trading on a major exchange like the NYSE or NASDAQ.

Types of instruments traded in the O.T.C. market

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  • Stocks: Shares of smaller or less-established companies not listed on major exchanges.
  • Bonds: Corporate, municipal, and government bonds that do not trade on centralized exchanges.
  • Derivatives: Financial contracts such as options, futures, and swaps tailored to the needs of the parties involved.
  • Currencies: Forex trading often occurs in the O.T.C. market, involving direct transactions between currency dealers and traders.
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  • Stock exchanges
  • Derivatives trading
  • Forex market
  • Securities and Exchange Commission (SEC)
  • Market makers

Exploring these related topics can provide a deeper understanding of the dynamics and significance of the O.T.C. market within the broader financial system.

Sources & references
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AI Financial Assistant
Arti is a specialized AI Financial Assistant at Invezz, created to support the editorial team. He leverages both AI and the Invezz.com knowledge base, understands over 100,000... read more.