Money market derivatives definition
INVESTOPEDIA EXPLAINSOTC markets are primarily used to trade bonds, currencies, derivatives and structured products. They can also be used to trade equities, such as the OTCQX, OTCQB and OTC Pink marketplaces (previously the OTC Bulletin Board and Pink Sheets) in the U.S. Broker-dealers that operate in the U.S. OTC markets are regulated by the Financial Industry Regulatory Authority (FINRA).
OTC markets are typically bifurcated into the customer market – where dealers trade with their clients such as corporations and institutions – and the interdealer market, where dealers trade with each other. The price a dealer quotes to a client may very well differ from the price it quotes to another dealer, and the bid-ask spread may also be wider in the case of the former than in the latter.
While OTC markets function well during normal times, their lack of transparency can cause a vicious circle to develop during times of financial stress, as was the case during the 2007-08 global credit crisis. Mortgage-backed securities and other derivatives such as CDOs and CMOs, which were traded solely in the OTC markets, could not be priced reliably as liquidity totally dried up in the absence of buyers. This resulted in an increasing number of dealers withdrawing from their market-making functions, exacerbating the liquidity problem and causing a worldwide credit crunch. Among the regulatory initiatives undertaken in the aftermath of the crisis to resolve this issue was the use of clearinghouses for post-trade processing of OTC trades.
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