OTCMrkets - BACK TO BASICS Over-the-Counter Randall Dodd...

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34 June 2008 F INANCIAL markets are complex organizations with their own economic and institutional structures that play a critical role in determining how prices are es- tablished, or “discovered.” These factors also shape the stability and orderliness of the marketplace. As holders of subprime collateralized debt obligations (CDOs) and some derivatives have found out in the months following the Au- gust 2007 onset of the current turmoil, some types of markets can very quickly become unstable, disorderly, or otherwise dysfunctional. There are two basic ways to organize financial markets— exchange and over the counter (OTC)—although some recent electronic facilities blur the traditional distinctions. Trading on an exchange Exchanges, whether stock markets or derivatives exchanges, started as places where trading takes place. The best known is the New York Stock Exchange (NYSE). The Chicago Board of Trade has been trading futures contracts since 1851, and its recent merger with its longtime rival, the Chicago Mer- cantile Exchange, has created the largest derivatives exchange in the world. There are more than 100 stock and derivatives exchanges throughout the developed and developing world. But exchanges are more than physical locations. They set the institutional rules that govern trading and provide the information conduits and clearing facilities through which trading occurs and post-trading activities are completed. An exchange centralizes the communication of bid and offer prices to all market participants, who can respond by selling or buy- ing at one of the quotes or by replying with a different quote. Depending on the exchange, the medium of communication can be voice, hand signal, or electronic message. When two parties reach agreement, the price at which the transaction is executed is communicated throughout the market. 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. The advent of electronic trading has meant that exchanges don’t have to be physical places. Indeed, many traditional trading floors are being closed, and the communication of orders and executions are conducted entirely electronically. The London Stock Exchange and NASDAQ stock exchange
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This note was uploaded on 03/08/2011 for the course ECONOMIA 44 taught by Professor Jose during the Spring '11 term at Universidad Carlos III de Madrid.

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OTCMrkets - BACK TO BASICS Over-the-Counter Randall Dodd...

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