Question

Demonstrate the potential benefits and problems for a corporation and a potential
investor in trading the securities in the over-the-counter (OTC) market?

Requirements

Min 200 words

0% plagiarism rule

Answer 1

OTC market means Over The Counter market. It is a market place that doesn't include any centralized market or exchange hence these are deregulated. Here both the parties meet directly and interact personally to finalize a trade deal.

Advantages associated with OTC are:

• There are many companies that do not qualify the listing criteria due to smaller and less liquidity, hence cannot raise capital through centralized exchanges. These types of firms get an advantage through OTC markets for fundraising.
• There are cost benefits attached in OTC as less cost are borne in issuing new securities and servicing cost for investors.
• They allow more flexibility than normal exchange as in OTC the company can dictate its own terms and conditions
• The information availability and flow to the investors are better as they are in direct contact with the company.
• No middle man is involved like brokers or dealers so no brokerage or dealership charges which are generally hidden.

There are also some disadvantages to OTC which are mentioned below:

• There is a huge systematic risk for the investors as the scope and nature of the risk are unknown to the regulators. So it increases the systematic risk.
• Credit default risk has always been a challenge for investors. And here due to lack of clearinghouses and no involvement of exchange increases the default risk for an investor.
• There is an intrinsic risk involved while trading in OTC market i.e. manipulation of price as the OTC markets are generally illiquid and lack transperency due to which proper price discovery dosen't happens. Hence the trade which happens is just a mutual consent of both the parties.
• The bid and ask rate might have a huge diffrence which makes the trade deal less benificial and less effective.