Market Types and OTC vs Exchange

Trades are done in Markets. So, what are the types of Market?

• Primary Market: Financial instruments are listed for the first time here (like IPO). Does not involve share trading. Investors here earn money either through future dividends (if any) or if company wants to repurchase its shares. On an average these markets generate reliable long-term returns. Also called Money Raising Market.
• Secondary Market: The market where the financial instruments are traded for their lifetime, once they are created in primary markets. This is what we commonly know as ‘Stock Markets’. They provide liquidity to investors and help in Price Discovery (Current Price is defined by stream of future dividends expected).

Some financial or commodities instruments are traded on established exchanges. Examples include most highly-capitalized stocks, which trade on exchanges such as the New York Stock Exchange or Bombay Stock Exchange, and futures, which trade on futures exchanges such as the Chicago Board of Trade. These instruments are called exchange traded. The products at Exchange are standardized and the Exchange acts as a mediator for the trade. Also, The Exchange covers the Credit Risk by maintaining Margin Accounts for its members. Exchange may also provide clearing and settlement services. There could be types of exchanges like Stock Exchange, Futures & Options Exchange, Commodities Exchange, Foreign Exchange and so on.

An instrument is traded over-the-counter (OTC) if it trades in some context other than a formal exchange. Constitutes a network of brokers and dealers that trade stocks and bonds that are not listed on an Exchange and involves buying and selling securities outside the organized stock exchange. Brokers/Dealers negotiate most transactions by telephone, private leased lines and computer networks. Most debt instruments are traded OTC with investment banks making markets in specific issues. If someone wants to buy or sell a bond, they call the bank that makes a market in that bond and ask for quotes. Many derivative instruments, including forwards, swaps and most exotic derivatives are also traded OTC. In these markets, large financial institutions serve as derivatives dealers, customizing derivatives for the needs of clients. When traders want to trade non-standard or customized products or if they want to trade special or illiquid products then they need to trade OTC. Sometimes traders want to get into slightly less strict contracts than what an exchange allows them to with counter parties.

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