Over-the-Counter Market

What Is an Over-the-Counter Market?

An over-the-counter (OTC) market is a decentralized market wherein market participants trade stocks, commodities, currencies, or other instruments straightforwardly between two gatherings and without a central exchange or broker. Over-the-counter markets don't have physical areas; all things being equal, trading is directed electronically. This is totally different from a auction market system.

In an OTC market, dealers act as market-creators by providing cost estimates at which they will buy and sell a security, currency, or other financial products. A trade can be executed between two participants in an OTC market without others monitoring the price at which the transaction was completed. As a rule, OTC markets are normally less transparent than exchanges and are likewise subject to less regulations. Along these lines, liquidity in the OTC market might come at a premium.

Figuring out Over-the-Counter Markets

OTC markets are principally used to trade bonds, currencies, derivatives, and structured products. They can likewise be utilized to trade equities, with models like the OTCQX, OTCQB, and OTC Pink marketplaces (already the OTC Bulletin Board and Pink Sheets) in the U.S. Broker-dealers that operate in the U.S. OTC markets are regulated by the Financial Industry Regulatory Authority (FINRA).

Limited Liquidity

Sometimes the securities being traded over-the-counter lack buyers and sellers. Thus, the value of a security might change widely relying upon which market markers trade the stock. Furthermore, it makes it possibly dangerous assuming a buyer secures a critical position in a stock that trades over-the-counter would it be a good idea for them they choose to sell it sooner or later. The lack of liquidity could make it challenging to sell from here on out.

Risks of Over-the-Counter Markets

While OTC markets function well during normal times, there is an extra risk, called a counter-party risk, that one party in the transaction will default prior to the completion of the trade or won't make the current and future payments required of them by the contract. Lack of transparency can likewise make an endless loop create during times of financial stress, similar to the case during the 2007-08 global credit crisis.

Mortgage-backed securities and other derivatives like CDOs and CMOs, which were traded exclusively in the OTC markets, couldn't be priced dependably as liquidity completely evaporated without buyers. This brought about a rising number of dealers pulling out from their market-production functions, compounding the liquidity problem and causing a worldwide credit crunch. Among the regulatory drives attempted in the result of the crisis to determine this issue was the utilization of clearinghouses for post-trade processing of OTC trades.

A Real-World Example

A portfolio manager possesses around 100,000 shares of a stock that trades on the over-the-counter market. The PM concludes the time has come to sell the security and educates the traders to track down the market for the stock. Subsequent to calling three market creators, the traders return with awful news. The stock has not traded for 30 days, and the last sale was $15.75, and the current market is $9 bid and $27 offered, with just 1,500 shares to buy and 7,500 available to be purchased. As of now, the PM needs to choose if they need to try to sell the stock and find a buyer at lower prices or place a limit order at the stock's last sale with the hope of lucking out.

Features

• OTC markets don't have physical areas or market-creators.
• Over-the-counter markets are those wherein participants trade straightforwardly between two gatherings, without the utilization of a central exchange or other outsider.
• A portion of the products most generally traded over-the-counter incorporate bonds, derivatives, structured products, and currencies.