QS Study

Advantages and Disadvantages of Over the Counter Market (OTC)

In an OTC market, dealers act as market makers by quoting prices at which they will buy and sell a security or currency.

Advantages of OTC

  1. It provides a trading platform for smaller and less liquid companies as they are not qualified for listing on a standard exchange.
  2. It is a cost-effective method for corporate as there is a lower cost of new issues and lower expenses of servicing the investors.
  3. Family concerns and closely held companies can go public through OTC.
  4. Dealers can operate both in new issues and secondary market at their option.
  5. It gives greater freedom of choice to investors to choose stocks by dealers for market making in both primary and secondary markets.
  6. It is a transparent system of trading with no problem of bad or short deliveries.
  7. Information flows are free and more direct from market makers to customers since there is close contact between them.

Disadvantages of OTC

  • Lack of a clearing house or exchange results in increased credit or default risk associated with each OTC contract.
  • Precise nature of risk and scope is unknown to regulators which leads to increased systemic risk.
  • Lack of transparency.