Saturday, September 19, 2009

the informal over-the-counter market

The large maturity of securities bought and sold in the United States, especially debt securities are traded over-the-counter (OTC) and not on organized exchanges. The customer places a buy or sell order with a bank, broker, or dealer which is ten relayed via telephone, by wire, or by computer terminal to the particular dealer or broker with securities to sell or an order to buy. Each broker or dealer seeks the best possible price on behalf of himself or his customer, and the resulting competition to find the "best deal" brings together traders located hundreds or thousands of miles apart. The prices of actively traded securities respond almost instantly to the changing forces of demand and supply so that security prices constantly hover at or near competitive, market-determined levels.
All money market instruments are traded in the over-the-counter markets as are the large majority of government (federal, state, and local) bonds and corporate bonds. While most common stocks are traded on the exchanges, an estimated one quarter to one third of all stocks are traded OTC. The OTC Market is generally preferred by financial institutions, especially commercial banks, bank holding companies, mutual funds, and insurance companies, because in many cases their shares are not actively traded and OTC trading and disclosure rules are less restrictive. The presence of financial institutions tends to give the OTC market a more conservative tone than the exchanges.
Many dealers in the OTC market act as principal instead of brokers as on the organized exchanges. That is, they take "positions of risk" by buying securities outright for their own portfolios as well as for retail customers. Several dealers will handle the same stock so the customer can shop around. All prices are determined by negotiation with dealers acquiring securities at a bid price and selling them at an asked price. The OTC market is regulated by a code of ethics established by National Association of security Dealers, a private organization which encourages ethical behavior among its members. Trading firms or their employees who break NASD‘S regulations may be fined, suspended, or thrown out of the organization.
One of the most important contributions of NASD in recent years has been the development of NASDAQ-the National Association of security Dealers Automated Quotations System. Launched in 1971, NASDAQ displays bid and asked prices for thousands of OTC-traded securities on video screens connected electronically to a central computer system. All NASD-member firms trading in a particular stock report their bid-ask price quotations immediately to NASDAQ. This nation-wide communications network allows dealers, brokers, and their customers to determine instantly the terms currently offered by major securities dealers.

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