Over-the-counter
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The over-the-counter (OTC) derivatives market refers to a marketplace that is conducted off-exchange. These derivatives are privately negotiated between two parties, compared to listed derivatives traded through an established exchange or other intermediary.
The most commonly traded OTC derivatives are swaps, forward rate agreements, and exotic options. The market in OTC derivatives is much larger than that in exchange-traded derivatives, and it is unregulated. These derivatives are also vulnerable to counterparty risk, because the validity of a contract depends on the counterparty's ability to honor its obligations, rather than using an exchange clearing house as the guarantor.
Decentralized trade is carried out over the telephone, electronically or over a fax machine. Dealers carry inventories of product and facilitate the buy and sell orders of market participants.
According to the Bank for International Settlements, the total outstanding notional value of over-the-counter derivatives stood at $516 trillion as of June 2007.[1]
OTC credit derivatives have been blamed in part for the financial crisis. It is said that these allowed banks to think they were cutting risks when in fact they were just being hidden in a web of private trades.
U.S. Treasury Secretary Tim Geithner is quoted in British Mail Online on May 16, 2009, saying that he wanted most OTC derivatives trading to move to being traded through exchanges.[2]
References
- ↑ "Triennial and semiannual surveys on positions in global over-the-counter (OTC) derivatives markets at end-June 2007," 11/21/08. Bank for International Settlements. Retrieved on Jan. 28, 2008.
- ↑ LSE could win in shake-up of derivatives. Mail Online. Retrieved on May 19, 2009.
