Over-the-counter (OTC) trading (also called off-exchange trading) is any trading performed without a formal exchange. Parties may arrange transactions independently, but over-the-counter markets are often facilitated by brokers, who arrange deals but are not a party to those deals, or dealers, who quote prices they are willing to transact at.
Examples of over-the-counter markets are
- the secondary market for US Treasury securities
- the secondary market for most corporate bonds
- foreign exchange
- exotic or customized derivatives
- many vanilla derivatives (including forwards, swaps, caps and floors)
- penny stocks and other stocks of marginal companies
Most over-the-counter markets have limited transparency, although foreign exchange markets for major currencies are highly liquid and quite transparent. In OTC derivatives markets, bid-offer spreads can be enormous, but dealers hide this by quoting only one side to clients. They may also add service fees that can cost unwary institutional clients hundreds of thousands or even millions of dollars. A lack of transparency in penny stocks facilitates “pump and dump” schemes and other forms of manipultion.