• OTC Derivatives

    OTC (Over the Counter) Derivatives are customized and privately negotiated contracts for which the terms and conditions of the contract are mutually decided by the parties involved in the transaction. These contracts are traded and negotiated directly between two parties without being involved with any Exchange – which gives the Over the counter name.

    OTC derivative market is the largest market in terms of trading and volume and highly unregulated till Dodd Frank rule came into force in 2010. As no exchange is involved here, counterparty risk or default risk is very high which poses significant risk for the financial market as well.

    Different types of OTC Derivatives are:

    Benefits of OTC Derivatives:

    • All the terms and conditions can be modified based on requirement of both the parties
    • Margin money is not a requirement of OTC derivatives as this depends based on the agreement between buyer and seller
    • Can be terminated easily before expiry date
    • Can be transferred to other interested party if one party does not want to continue

    Disadvantages of OTC derivatives:

    • Unregulated compared to Exchange Traded Derivatives even after Dodd Frank act
    • Involving Credit and Default risk as no margin money is collected and counterparty can default on payment when due
    • More risky due to higher default risk and no proper regulation mechanism

     

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