OTC (Over-The-Counter)

The OTC is a market where financial instruments such as currencies, stocks, commodities, bonds etc are traded directly between two parties as opposed to a centralized exchange (such as the NYSE, CME, LME, NSE, etc). Trading occurs via a network of dealers, who carry inventories of securities to facilitate the buy and sell orders of investors, rather than providing the order matchmaking services as seen in exchanges. The OTC markets provide flexibility. As there are no limits on order quantity, nature of positions or margins (when trading with leverage) and flexibility- as one can customize a particular contract. This increases the counterparty (credit) risk because if either party defaults there are no or minimal formal rules or regulations to safeguard the investors interests. This increases the bid-ask spread of dealers as they have to price in this credit risk while trading.