Legal Definitions - OTC MARKET

The term OTC MARKET is an abbreviation for Over-The-Counter Market.

An Over-The-Counter Market is a decentralized market where financial instruments, such as stocks, bonds, commodities, or derivatives, are traded directly between two parties, rather than through a centralized exchange like the New York Stock Exchange (NYSE) or NASDAQ. In an OTC market, prices are negotiated directly between buyers and sellers (or their brokers/dealers) through a network of participants, often using electronic communication. This type of market typically has less stringent listing requirements compared to major exchanges, making it accessible for smaller companies or less liquid securities.

Here are some examples to illustrate the OTC market:

• Example 1: Trading Shares of a Small Startup

  Imagine a promising new biotechnology startup that is still relatively small and does not yet meet the strict financial and operational requirements to be listed on a major stock exchange. Investors who wish to buy or sell shares in this company would typically do so through an OTC market. A broker-dealer might facilitate a transaction by finding a buyer for an existing shareholder's stock, negotiating the price directly between the two parties. This direct negotiation, outside of a formal exchange, is a hallmark of the OTC market.

• Example 2: Institutional Bond Trading

  A large institutional investor, such as a pension fund, wants to purchase a significant quantity of corporate bonds issued by a well-established company. Instead of buying these bonds on a public exchange, the pension fund's trading desk might contact several major investment banks directly. These banks, acting as dealers, would then offer to sell the bonds from their own inventory or source them from other sellers. The price and terms of the bond transaction are negotiated privately between the pension fund and the investment bank, making this a transaction within the OTC market for bonds.

• Example 3: Foreign Currency Exchange

  The global foreign exchange (forex) market, where currencies like the US Dollar, Euro, and Japanese Yen are traded, is the largest OTC market in the world. When a multinational corporation needs to convert a large sum of Euros into US Dollars to pay for imports, it typically does not go to a centralized exchange. Instead, it contacts its bank or a specialized forex dealer. The bank or dealer then quotes a price, and the transaction is executed directly between the corporation and the financial institution. This vast, decentralized network of banks, corporations, and other financial institutions trading currencies directly with each other constitutes an OTC market.