Monday, December 27, 2010

Over The Counter

The term Over The Counter (OTC) refers to trade in financial instruments and securities that does not take place on a recognized exchange. For example most swaps and forward contracts are traded OTC because it is impractical to trade on exchange due to the customised and complex nature of the contracts (exchange traded contracts must be standardised). Much of the OTC trade in financial instruments and securities takes place between Investment Banks, Commercial Banks, Inter Dealer Brokers, and other financial institutions. Many investment funds will enter into OTC transactions for a variety of instruments and reasons e.g. hedging foreign exchange exposure via forward contracts, obtaining index exposure via index return swaps, etc. When institutions trade OTC they take on counter-party risk and liquidity risk because there is usually no clearing house and may be no liquid market for the instrument - particularly for highly bespoke contracts.

Synonyms: OTC,  OTC derivatives, OTC market

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