Exchange-Traded vs OTC: Financial markets provide different platforms for investors to buy and sell securities. The two main methods are Exchange-Traded and Over-the-Counter (OTC). While both facilitate trading, they differ significantly in structure, regulation, transparency, and accessibility.
For bank exam aspirants, especially for IBPS, RBI, SEBI, and UPSC, this topic is crucial under the Financial Awareness & Capital Markets section. Let’s break it down in detail.
What is Exchange-Traded?
Exchange-traded securities are those bought and sold on a centralized trading platform, such as the NSE, BSE, NYSE, or NASDAQ. These exchanges provide a transparent marketplace where investors can place orders, and trades are executed following strict rules.
- The exchange acts as a middleman, ensuring fair practices.
- Trades are cleared and settled through a clearinghouse, which eliminates counterparty risk.
- Products include stocks, ETFs, standardized derivatives, and commodities.
What is over-the-counter (OTC)?
The OTC market refers to securities trading that takes place outside exchanges, directly between two parties, typically large financial institutions, dealers, or high-net-worth investors.
- Deals are negotiated privately, allowing customization of contracts (e.g., derivatives, forward contracts, corporate bonds, and forex).
- OTC markets are less regulated, and transactions are not always publicly disclosed.
- While flexible, OTC carries higher counterparty risk, as there is no central clearing authority.
Features of Exchange-Traded vs OTC
The table below outlines the basic features:
| Feature | Over-the-Counter (OTC) | Exchange-Traded |
| Definition | Direct, decentralized trading between two parties. | Centralized platform with standardized rules and intermediaries. |
| Market Participants | Mostly financial institutions, dealers, hedge funds. | Retail investors, institutions, market makers, brokers. |
| Trading Hours | Continuous, often 24/7. | Limited to official exchange hours. |
| Products Traded | Customized derivatives, corporate bonds, forex, exotic instruments. | Stocks, ETFs, standardized futures, options, commodities. |
| Price Discovery | Private negotiation between buyer and seller. | Transparent order book based on supply and demand. |
| Transparency | Low—prices and terms are not disclosed publicly. | High—all trades are reported in real time. |
| Liquidity | Depends on size and interest of counterparties. | Higher, as many participants create active markets. |
| Regulation | Limited, varies by country. | Strict oversight by regulators (e.g., SEBI, SEC, CFTC). |
| Execution Speed | Quick, since transactions are bilateral. | May be slower due to matching and clearing processes. |
| Settlement | Bilateral settlement; counterparty assumes risk. | Central clearing eliminates counterparty risk. |
| Costs | Higher due to lack of competition and customization. | Lower, driven by competition and standardization. |
| Accessibility | Restricted to large players, not retail-friendly. | Widely accessible via brokers and online platforms. |
| Reporting | Not always reported or made public. | All trades are recorded, monitored, and disclosed. |
Key Differences Between OTC and Exchange
The following table summarizes the core differences in an exam-friendly format:
| Aspect | OTC | Exchange-Traded |
| Regulation | Minimal oversight, decentralized. | Heavily regulated by exchanges & regulators. |
| Price Discovery | Based on negotiation; opaque. | Transparent, based on market demand and supply. |
| Counterparty Risk | High, since contracts are bilateral. | Low, clearinghouse manages settlement. |
| Liquidity | Limited, depends on counterparties. | High, due to large participation. |
| Standardization | Highly customizable contracts. | Standardized contracts and securities. |
| Accessibility | Restricted to institutions. | Accessible to both retail and institutional investors. |
| Reporting | Limited or no reporting of trades. | All trades disclosed publicly in real time. |
| Suitability | Complex instruments, tailored needs of institutions. | Common securities and widely traded instruments. |
Why This Matters for Bank Exam Aspirants?
Banking and regulatory exams often test the difference between OTC and exchange-traded markets. Candidates should note:
- Exams like IBPS, RBI Grade B, SEBI, and UPSC EPFO frequently ask direct and indirect questions.
- Questions can appear in MCQ format (e.g., “Which market has higher counterparty risk?”).
- Understanding these differences also builds clarity in topics like derivatives, forex markets, and capital markets.
Practice Questions on Exchange-Traded vs OTC
Q1. What is the main difference in trading structure between exchange-traded and OTC markets?
Q2. Which market is more transparent in terms of price discovery?
Q3. In which market is counterparty risk higher—Exchange or OTC?
Q4. Name one product commonly traded on exchanges.
Q5. Name one product commonly traded in OTC markets.
Q6. Which market allows more customization of contracts?
Q7. Which market operates during fixed hours, exchange or OTC?
Q8. Liquidity is generally higher in which type of market?
Q9. Which type of market is more regulated—Exchange or OTC?
Q10. In which market are trades settled through a central clearinghouse?
Q11. Which market is usually more accessible for retail investors?
Q12. Which market is generally limited to large institutions and high-net-worth individuals?
Q13. State one advantage of exchange-traded markets.
Q14. State one disadvantage of OTC markets.
Q15. Which market usually involves higher costs due to lack of price competition?
Answer Key
| Q. No. | Answer |
| Q1 | Exchange = Centralized, OTC = Direct bilateral trading |
| Q2 | Exchange-Traded |
| Q3 | OTC |
| Q4 | Stocks / ETFs / Futures |
| Q5 | Derivatives / Corporate Bonds / Forex |
| Q6 | OTC |
| Q7 | Exchange |
| Q8 | Exchange-Traded |
| Q9 | Exchange-Traded |
| Q10 | Exchange-Traded |
| Q11 | Exchange-Traded |
| Q12 | OTC |
| Q13 | Transparency / Central clearing / Lower risk |
| Q14 | Lack of transparency / High counterparty risk |
| Q15 | OTC |
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