Dealer Markets / OTC

CFA Level I Equities
#1

Cheers guys,

please excuse my ignorance but could someone please elaborate on the different terminologies?
Wherever I look I find different and contradicting explanations.

Are OTC markets = Dealer markets (as stated in my Schweser notes)? My understanding is that OTC means there’s just 2 parties making a deal without an intermediary. But… if there is a Dealer acting as intermediary, then why would one have counter-party risk. On the other it says Futures are traded in Dealer Markets, which I thought trade on exchanges… So there must be a difference. Or, do Dealers simply Buy/sell on an exchange? Or do dealers buy/sell in OTC markets, along with other participants posting bids and asks (from whom the potential counter party risk stems)?

Could someone please explain why these are the same or why they are different and maybe give an example?

#2

Dealers aren’t intermediaries; they’re counterparties, buying for and selling from their own inventory.

For exchange-traded derivatives, the exchange is the dealer, and they don’t default (in theory). For OTC markets, Bob-the-futures-guy is the dealer, and Bob might default.

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#3

Alright, I understand. So Bob and the exchange can both be dealers depending on the circumstances.

Thank you for your wisdom, really appreciate it!

1 Like
#4

My pleasure.

1 Like
#5

Exactly what s2000 says. He’s always right anyway. Don’t confuse broker with dealer. You can have entities that do both of course. But a broker is an intermediary between 2 parties. A dealer is acting as one of the parties. To put it in a colorful way, a drug dealer is not connecting people and charging a fee. They are selling you inventory from their supply. They are a dealer. A real estate broker does not own the house unless it happens to be their house by random chance. They are acting as an intermediary between a buyer and a seller. They are a broker.

Cheers you got this👍

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#6

Brokers are your friends; dealers are your enemies.

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#7

Ok, noted, I certainly prefer friends!

One more thing that I just came across: With ETFs, which trade on an exchange, how can there be dealers? Do the dealers / market makers in that case compete with good old Joe for the shares? And if I am selling, either could be on the other side of my trade? OR: Are the bespoke Market Makers in this case the Authorised Participants, creating and Redeeming ETF Shares (which would also kinda confirm my first point of course)

2 Likes
#8

Here is a good article on ETFs in case it’s helpful:

https://www.google.com/url?sa=t&source=web&rct=j&url=https://www.vanguardinvestments.dk/documents/understanding-etf-liquidity.pdf&ved=2ahUKEwiZy8CC77PyAhVaGs0KHRQKDnQQFnoECAUQAQ&usg=AOvVaw1WsomEtZHGLeN34onHWGG3

And here is another one:

https://www.google.com/url?sa=t&source=web&rct=j&url=https://www.rbcgam.com/documents/en/articles/what-is-the-role-of-the-market-maker-for-etfs.pdf&ved=2ahUKEwj5gtuL8bPyAhXVQs0KHVEpBzEQFnoECCgQAQ&usg=AOvVaw2wETQ6wLfcfH3JPKHDb4bo

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#9

Many thanks, very useful papers! The first link doesn’t work but was not difficult to find it on google.
So, I read both, the first one distinguishes between Market Makers and Authorised Participants, the second one does not, there MMs are the AP’s. But thats fine, The takeaway is: Market Makers engage on regular exchanges and they can be the AP for ETFs.

Sorry to be so nit-picky, but I want to really understand the differences instead of just memorising facts.

Alright, lights out! You guys have a good day in the states.

1 Like
#10

Cheers you got this :+1:

#11

Results are out…
Thanks for all the support here guys, passed within the 90th percentile. Would not have been possible without you folks!

Many many thanks

1 Like
#12

Congratulations, Markus!

My pleasure.

#13

Great work - you definitely got this :+1: