Secondary market refers to a market wherein already issued securities and financial instruments are traded. It includes both exchanges and OTC market. Exchange refers to the formally established stock exchange wherein securities are traded and they have a defined set of rules for the participants.
When the trading is performed through the exchange, it is under the supervision of the exchange and so it ensures that all the rules and regulations are duly complied with. Conversely, Over the Counter, shortly known as OTC is a dealer oriented market of securities, which is a decentralized and unorganized market where trading happens by way of phone, emails, etc.
The difference between OTC and Exchange are discussed below in detail.
Content: OTC Vs Exchange
Comparison Chart
| Basis for Comparison | OTC (Over the Counter) | Exchange |
|---|---|---|
| Meaning | Over the Counter or OTC is a decentralized dealer market wherein brokers and dealers transact directly via computer networks and phone. | Exchange is an organized and regulated market, wherein trading of stocks takes place between buyers and sellers in a safe, transparent and systematic manner. |
| Market maker | Dealer | Exchange itself |
| Used by | Small companies | Well established companies |
| Physical Location | No | Yes |
| Trading hours | 24×7 | Exchange hours |
| Stocks | Unlisted Stocks | Listed Stocks |
| Transparency | Low | Comparatively high |
| Contracts | Customized | Standardized |
Definition of OTC
OTC or Over the counter market is a decentralised market for unlisted securities, not having a specific physical location, rather the firms/persons involved in trading directly negotiate over a communication network such as telephone lines, emails, computer terminals, etc. Trading Over the counter is also called off-exchange trading, because of the absence of a formal exchange.
In general, those companies which do not fulfil the prerequisites of the stock exchange for listing their stocks, trade them over the counter. The trade takes place between two companies or financial institutions. Financial products such as bonds, derivatives, currencies, etc. are mainly traded OTC.
It is a dealer’s market, where they buy and sell the financial products for their account and the investors can directly contact the dealers, who are interested in selling their stocks or bonds they have or they can talk to the brokers, who will find out the dealers offering the stocks with the best price.
The dealers making the market for a certain securities quote the price at which they are going to pay for the stock called as the bid price and the rate at which they are going to sell the stock is called ask price. Here, the bid-ask spread implies the amount left in-between the bid and asked prices indicating the markup of the dealer.
Definition of Exchange
Exchange refers to the exchange-traded market, which refers to a centralized and regulated financial market, where securities, commodities, derivatives, etc. of listed companies are bought and sold between stockbrokers and traders.
The prices of securities such as shares, debentures, notes, corporate bonds, etc. are decided by the market demand and supply forces. It can be a physical trading location such as premises, etc. or it can be an electronic platform, i.e. website.
It has an association of persons (registered or unregistered) commonly referred to as member brokers. It is established with the aim of governing the trade of securities by the general public and companies, as a whole. There is a set of rules imposed by the Exchange on the firms and brokers, which participate in the trading of securities.
Features of an Exchange
- Trading of Securities: The first and foremost function of a stock exchange is to provide a formal platform for trading of securities and liquidating them whenever an investor needs to encash them, at the prevailing market price. Moreover, it provides the flexibility to the investor to change their portfolio whenever required.
- Ascertainment of price: An Exchange-traded market is one of the best examples of perfect competition, because of the presence of many buyers and sellers in the market. As the market is transparent, all the necessary information is available and so active bidding takes place and in this way, the price is decided.
- Raising funds: Stock exchange is commonplace for the companies and governments to generate funds from the market by offering securities for sale to the general public.
- Mobilization of savings: People invest their savings in the share market, to earn good returns and make money out of their investments. In this way, the savings of the public is mobilized and channelised by the stock exchanges, by investing their money in different sectors, which generate high returns.
- Trades in second-hand securities: In an exchange, only those securities are traded which are previously issued by the companies through a public offering in the primary market.
Key Difference Between OTC and Exchange
The difference between OTC and Exchange can be drawn clearly on the following grounds:
- Exchange implies a trade exchange which can be an organization or institution, that hosts a market where stocks of listed companies are traded between the buyers and sellers. On the other hand, OTC expands to over the counter, which refers to a decentralised market, wherein buyers look for sellers and vice versa to communicate with each other by way of computer network or phone.
- In an over the counter market the dealers play the role of market makers, as they quote the price at which the securities and other financial instruments are bought and sold between the participants. Conversely, in case of an exchange, the trading exchange is the market maker, as the prices are determined by the demand and supply forces.
- The companies which do not follow the guidelines and meet the requirements of the exchange often trade their securities OTC, which are generally small companies. As against, big business houses usually go for listing and trading their stocks through an exchange.
- One of the main difference between these two is that an exchange is physically present, wherein the open outcry method is used. In contrast, OTC has no physical location, everything is phone-based or computer-based.
- In an exchange, trading is performed during trading hours only. On the contrary, in OTC, trading is performed 24×7.
- When it comes to transparency, the OTC market is not as transparent as an exchange, where the participants have complete information and knowledge about the securities being traded.
- In case of an exchange only standardized products, in terms of quality and quantity are dealt, whereas in case of an OTC the contracts are customized as per the requirement.
- Due to short term imbalance between the demand and supply, there is no mechanism in the OTC market to stop acute highs or lows in the security prices. However, in an exchange, these imbalances in prices are managed by exchange halting trading in a particular stock, that lets the additional participants restore market equilibrium.
Conclusion
At the end of the discussion, we can say that an exchange is obviously a step ahead of the OTC due to certain reasons such as it provides liquidity to encash the securities whenever required, transparency in terms of availability of information, flexibility to change the investment portfolio at any time, less risk and maintenance of fair price.
Silvana says
Thank you for the content.