Over-The-Counter (OTC)

Financial Dictionary -> Investing -> Over-The-Counter (OTC)

In periods of rapidly changing financial and economic environment, understanding how global trade works has become a skill of paramount importance to one's well-being and prosperity. In this sense, mastering one of the most popular trading methods, namely, the over-the-counter trading or OTC is a vital necessity for those who aim at stable financial future.

You probably have some information about the stock exchanges around the world. They get like representations in some TV series, as places buzzing with activity, with some people rushing to and fro, yelling like mad and, occasionally, raising huge labels with some strange signs on them. In reality, financial brokers do shout sometimes, as stock exchanges are particularly noisy, but more important, these are places where the shares of some of the biggest and strongest companies in the world are publicly traded. Some of these are Capital Bank, Bank of Florida, Microsoft, Merrill Lynch & Co, etc. All of them have the permission to offer registered bonds, stocks, and other registered securities for sale to the general public.

Having said that, we can use the above statement as a stepping stone, which to help us understand OTC. As a trading method, OTC represents an alternative to the stock exchanges such as the New York Stock Exchange, the Tokyo Stock Exchange, the Toronto Stock Exchange, etc, whereby stocks, securities and other financial instruments are traded via an established network of dealers which, in itself, is a more flexible structure than a common, centralized stock exchange.

But why, you may ask, do we need OTC since we have such big and well-working stock exchanges like the ones mentioned above? It's a good question, I must admit, and it deserves an equally good and exhaustive answer. As it's clear already, the stock exchanges are the immediate choice of the market giants and corporations but, as you might have figured out already, not all companies are equal in size and strength. In this line of thoughts, OTC gives a chance to some smaller companies to see their shares traded, although their market capitalization is not strong enough to meet the stock exchange listing criteria. Instead, the shares of these companies are put on the Over the Counter Bulletin Board (OTCBB). By the same token, the dealers who trade in these unlisted stocks do not gather in huge halls to shout in one another's ear, but do their job in much calmer and peaceful manner using their mobile phones or communicating through special online trading channels.

In the United States, OTC is carried out by companies or individuals (market makers), making markets in Pink Sheets and OTCBB securities. OTC stocks are not typically traded on the stock exchanges, but stocks listed on the latter may be traded over-the-counter. Stocks that are quoted on the OTCBB have to comply with the reporting requirements of the US Securities and Exchange Commission. Other stocks, for example Pink Sheets, do not have reporting requirements to comply with. Some of the more notable securities traded over the counter include bonds and securities issued by the US government, as well as state municipal bonds. Some mutual funds in the United States and Canada also trade their shares over the counter to take advantage of the so-called 'volume discounts' that this trading method offers.