Section 8.2 – The OTC, Third, and Fourth Markets

  • The OTC Market (Over-the-Counter Market)

    • he OTC market is a decentralized market — there is no physical trading floor.

    • It is primarily used by smaller companies that do not meet listing requirements of an exchange.

    • Securities traded here are called non-listed or unlisted securities.

    • Most debt securities (corporate and municipal bonds) are traded in the OTC market.

Key Features of the OTC Market:

  • No central exchange or floor – All trades are done electronically or by phone.

  • Market Makers – Specialized broker-dealers who:

    • Maintain an inventory of securities they trade.

    • Post quotes (bid and ask prices) to show the prices at which they’ll buy and sell.

    • Compete with other market makers for business.

  • Investor Transactions

    • When an investor buys, they are buying from a market maker.

    • When an investor sells, they are selling to a market maker.

  • Broker-Dealers’ Roles

    • A broker-dealer may assist a customer by locating a market maker — in this case, they are acting as an agent and may charge a commission.

    • Market makers earn profits from the spread (the difference between the bid and ask prices).

    • A broker-dealer cannot act as both an agent and a market maker (principal) in the same trade.

NASDAQ and OTC:

  • NASDAQ is part of the OTC market — it is an electronic quotation system for securities trading.

  • While part of the OTC system, it’s highly organized and mainly features larger, well-established companies.

The Third Market (NASDAQ Intermarket):

  • The third market is where exchange-listed securities are traded over the counter (OTC).

  • Participants: Primarily institutional investors.

  • Example: A mutual fund buying NYSE-listed stock through an OTC dealer instead of directly on the NYSE.

  • All NYSE-listed and most regional exchange-listed securities are eligible for OTC trading.

The Fourth Market

  • The fourth market involves direct trading between institutional investors, often large blocks of stock.

  • These trades are done without a broker-dealer (no middleman).

  • Trades often occur on Electronic Communication Networks (ECNs) or private systems.

  • Orders in this market are not public until after the trade is complete.

  • Purpose: To reduce transaction costs and increase efficiency for large institutions.

Trading Hours

  • NYSE (Exchange): 9:30 AM – 4:00 PM ET

  • Retail OTC Market: Normal hours are the same (9:30 AM – 4:00 PM ET).

  • Extended Hours: Many OTC market makers remain open until 6:30 PM ET to handle after-hours trading.

Next Section

More Markets

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More Markets 〰️

✺ Review questions ✺

  • Over-the-Counter; smaller companies that are not listed on exchanges.

  • Unlisted (non-listed) securities.

  • Broker-dealers who maintain an inventory of securities, post bid and ask quotes, and profit from the spread.

  • By buying from or selling to a market maker.

  • As an agent, charging a commission.

  • No, they must choose one role.

  • The trading of exchange-listed securities over the counter (OTC), typically by institutional investors.

  • Direct trading between institutional investors, usually large blocks, without a broker-dealer.

  • 9:30 AM to 4:00 PM ET, with OTC often extending until 6:30 PM ET.