![]() All of the securities and derivatives involved in the financial turmoil that began with a 2007 breakdown in the US mortgage market were traded in OTC markets. ![]() OTC markets are less transparent and have fewer rules than exchanges. Some exchanges designate certain participants as dedicated market makers and require them to maintain bid and ask quotes throughout the trading day. ![]() Exchanges are far more liquid because all buy and sell orders as well as execution prices are exposed to one another. Moreover, dealers in an OTC security can withdraw from market making at any time, which can cause liquidity to dry up, disrupting the ability of market participants to buy or sell. That does not mean they quote the same prices to other dealers as they post to customers, and they do not necessarily quote the same prices to all customers. Dealers act as market makers by quoting prices at which they will sell (ask or offer) or buy (bid) to other dealers and to their clients or customers. Unlike exchanges, OTC markets have never been a “place.” They are less formal, although often well-organized, networks of trading relationships centered around one or more dealers. Brazil’s BM&F maintained both until 2009. The NYSE bought the electronic trading platform Archipelago and is moving increasingly toward electronic trading, as is derivatives exchange CME Group, which maintains both open-outcry and electronic trading. Many others offer both floor and electronic trading. The London Stock Exchange and the NASDAQ Stock Market are completely electronic, as is Eurex, a major futures exchange. Many traditional trading floors are closing, and orders and executions are now all communicated electronically. The result is a level playing field that allows any market participant to buy as low or sell as high as anyone else as long as the trader follows exchange rules.Įlectronic trading has eliminated the need for exchanges to be physical places. When two parties reach agreement, the price at which the transaction is executed is communicated throughout the market. Depending on the exchange, the medium of communication can be voice, hand signal, a discrete electronic message, or computer-generated electronic commands. An exchange centralizes the communication of bid and offer prices to all direct market participants, who can respond by selling or buying at one of the quotes or by replying with a different quote. They are closely linked to the clearing facilities through which post-trade activities are completed for securities and derivatives traded on the exchange. They set the institutional rules that govern trading and information flows about that trading. Today there are more than a hundred stock and derivatives exchanges throughout the developed and developing world.īut exchanges are more than physical locations. Some of the best known include the New York Stock Exchange (NYSE), which was formed in 1792, and the Chicago Board of Trade (now part of the CME Group), which has been trading futures contracts since 1851. ![]() Trading on an exchangeĮxchanges, whether stock markets or derivatives exchanges, started as physical places where trading took place. There are two basic ways to organize financial markets-exchange and over the counter (OTC)-although some recent electronic facilities blur the traditional distinctions. ![]() As holders of subprime collateralized debt obligations and other distressed debt securities found out in the months following the August 2007 onset of the financial turmoil that led to the global economic crisis, some types of market arrangements can very quickly become disorderly, dysfunctional, or otherwise unstable. These structures also shape the orderliness and indeed the stability of the marketplace. How securities are traded plays a critical role in price determination and stabilityįinancial markets are complex organizations with their own economic and institutional structures that play a critical role in determining how prices are established-or “discovered,” as traders say. ![]()
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