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FRM Part I · FRM Exam Part I · Exchanges and OTC Markets

In the structure of the OTC derivatives market, which feature explains why a small number of large dealers are central to the market?

Large dealers act as market makers, quoting bid and offer prices and taking the opposite side of end-user trades, then hedging with other dealers. This bilateral dealer-centered structure, rather than exchange listing or standardization, makes them central to OTC markets.

  1. ADealers act as market makers quoting bid and offer prices to end users, so many trades are bilateral with a dealer on one sideCorrect
  2. BDealers must be members of an exchange to trade OTC contracts
  3. COTC contracts are standardized so only dealers can list them
  4. DRegulation forbids end users from trading with each other or with dealers

Explanation

In OTC markets, dealers quote two-way prices and take the other side of end-user trades, then hedge or offset with other dealers. OTC contracts are not standardized or exchange-listed, and no rule bars end users from trading with dealers.

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