Options, Futures, and Other Derivatives, 10th Edition

2.5 OTC MARKETS

Over-the-counter (OTC) markets, introduced in Chapter 1, are markets where companies agree to derivatives transactions without involving an exchange. Credit risk has traditionally been a feature of OTC derivatives markets. Consider two companies, A and B, that have entered into a number of derivatives transactions. If A defaults when the net value of the outstanding transactions to B is positive, a loss is likely to be taken by B. Similarly, if B defaults when the net value of outstanding transactions to A is positive, a loss is likely to be taken by company A. In an attempt to reduce credit risk, the OTC market has borrowed some ideas from exchange-traded markets. We now discuss this.

Central Counterparties

We briefly mentioned ...