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Question

Difficulty: MediumTypes of Markets and Trading Venues

An investor purchases shares of a corporate stock that is not listed on a national exchange, executing the trade in the over-the-counter (OTC) market. Which of the following statements correctly describes a key operational characteristic of the OTC market?

  1. A
    The transaction directly provides capital to the issuing company, which receives the trade proceeds.
  2. It is a decentralized, negotiated market where transactions occur through market makers displaying bid and ask quotes.Answer
  3. C
    The executing broker-dealer must act strictly in an agency capacity and cannot fill the trade from its proprietary inventory.
  4. D
    The trade clearance and central counterparty netting process is performed by the Depository Trust Company (DTC).

Answer

The over-the-counter (OTC) market is a decentralized, negotiated market where transactions occur through market makers displaying bid and ask quotes.
The over-the-counter (OTC) market is a decentralized market structure without a physical floor, where participating market makers post bid and ask quotes to negotiate and execute secondary market trades.

Step-by-Step Solution

1
Identify the trading venue context.
The transaction occurs in the secondary over-the-counter (OTC) equity market.
Distinguishing between exchange trading and OTC trading establishes the execution structure.
2
Analyze the execution mechanism of the OTC market.
The OTC market relies on a inter-dealer network of market makers competing through published bid and ask prices rather than a single centralized exchange auction.
Market makers buy and sell securities for their own accounts or act as brokers for client orders across decentralized electronic networks.

Key Concept

OTC Market Structure and Execution Characteristics
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Topics

Types of Markets and Trading Venues

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