Over-the-Counter Derivatives (OTC):

Operations: OTC derivatives are privately negotiated contracts between two parties without the involvement of an exchange. These contracts are customized to meet the specific needs of the parties involved.
Advantages:
- Customization: OTC derivatives allow for greater flexibility and customization of contract terms to meet the specific risk management or investment objectives of the parties involved.
- Privacy: OTC transactions are typically confidential, providing privacy for participants’ trading strategies and positions.
- Variety of Instruments: OTC markets offer a wide range of derivative instruments beyond what is available in exchange-traded markets, including complex structures tailored to specific needs.
Disadvantages:
- Counterparty Risk: OTC derivatives expose participants to counterparty risk, as there is a reliance on the creditworthiness of the counterparty involved. This risk can be mitigated through credit assessments and collateralization.
- Limited Transparency: OTC transactions lack the same level of transparency and centralized pricing as exchange-traded derivatives. Price discovery may be less efficient, especially for less liquid instruments.
- Lack of Standardization: OTC contracts lack standardization, which can lead to challenges in valuing, comparing, and transferring these contracts. It may also create difficulties in hedging and risk management.