How does an over-the counter market work?

Fsp Invest, 13 Dec. 2013

Tags: otc, over-the-counter market, the difference between an otc market and an exchange



Sometimes you might hear people talking about an over-the-counter (OTC) market. You may think it’s just the same thing as a normal stock exchange, but there are some important differences. Differences that may affect how you choose to invest your money. Let’s take a closer look.


What is a stock exchange anyway? 
Let’s start out by looking at something you’re a little more familiar with—a normal stock exchange. 
 
Now, a normal stock exchange is a formal market place for buying and selling products like shares
 
They have very strict laws and regulations that govern them. 
 
And the products you buy are standard. They’ll have standard contracts set out by the exchange. 
 
Now, the benefit for you is you’re somewhat protected from credit risk.
 
And there is also greater liquidity. 
 
Which means you can buy and sell the product easily. 
 
The difference between an OTC market and an exchange
An over-the-counter (OTC) market is also a place where you can trade financial instruments. 
 
An OTC market consists of a group of dealers who buy and sell financial instruments. 
 
These dealers hope to make a profit from selling these products at a higher price than they bought them for. 
 
Bond markets are usually OTC markets. And you would normally trade equities on an exchange. 
 
An advantage of buying something OTC is you can have a tailor-made deal!
 
A deal that suits your specific needs and investment objectives. 
 
But the drawback is that you take on more credit risk! And you won’t be able to buy from and sell to other investors as easily. 
 
So, when you’re deciding whether to buy a security on an exchange or over-the-counter… 
 
You need to ask yourself if you’d prefer something less risky and more standardised. 
 
Or if you’re looking for something ultra-specific…  
 

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