Browse Canadian Investment Marketplace

2.4.3 Dealer Markets

Exploring the workings of dealer markets, including the over-the-counter trading of bonds, debentures, and unlisted equities. The guide illuminates the methods and advantages of trading in dealer markets and synthesizes regulatory nuances in Canada.

Dealer Markets

Dealer markets, also known as over-the-counter (OTC) markets, consist of a network of banks and investment dealers. Unlike auction markets, where orders from buyers and sellers are collated in a centralized marketplace, dealer markets operate as negotiated markets. Market makers in these environments post bid-and-ask quotations through electronic platforms and computer networks. Investment dealers typically act as principals in the OTC market.

Almost all bonds and debentures are transacted through dealer markets. Despite being less visible than auction markets for equities, the volume of trading (in dollar terms) for debt securities is significantly larger in dealer markets.

Dealer markets are often referred to as unlisted markets because the securities traded there are not listed on an organized exchange, as is customary in auction markets.

In dealer markets, transactions do not occur in a central marketplace. Instead, they are typically carried out on the OTC market. Trades are facilitated by the computer systems of inter-dealer brokers that enable transactions between investment dealers.

Did You Know?

The Unlisted Equity Market

The volume of unlisted equity business in dealer markets is much smaller than what transpires on stock exchanges. Despite many junior issues trading OTC, shares of some industrial companies also trade in this market. These companies’ boards might choose not to list one or more of their equity issues on a stock exchange for numerous reasons. The unlisted market does not impose minimum listing requirements nor attempts to regulate companies.

Many of the stocks traded in the unlisted market are more speculative and generally offer lower liquidity than those on listed markets.

Visual Representation—Example Snapshot of Dealer Markets Transaction: Non-Centralized Trading

    graph TD
	    A[Investment Dealer A] -->|Quote Bid/Ask Prices| B((OTC Market))
	    A[Investment Dealer A] --> C[Market Maker X]
	    A[Investment Dealer A] --> D[Market Maker Y]
	    D[Market Maker Y] --> E[Investor Order]
	    C[Market Maker X] --> E[Investor Order]
	    B((OTC Market)) --> |Facilitates| E[Investor Order]

Trading in the Unlisted Equity Market

Over-the-counter trading of equities takes place similarly to bond trading. No centralized and public market exists for individual investors’ orders. Instead, market makers quote their own bid and ask prices. Market makers maintain inventories of the securities they commit to trading, selling them to interested buyers against quoted prices.

The ability of market makers to offer bid and ask prices provides necessary liquidity to the system, albeit with the discretionary right to refuse to trade at these prices. Investors looking to buy or sell an unlisted security have their dealer consult multiple market makers’ quotations to find the best price before completing the transaction. This service incurs a commission charge by the dealer.

Over-the-Counter Derivatives Market

The OTC derivatives market is largely handled by major international financial institutions, including banks and investment dealers who trade with corporate clients and other financial entities. Traders conduct their negotiations asynchronously, ensuring the market operates incessantly, 24 hours a day.

One of the appealing features of OTC derivative products is their customizability by buyer and seller to include special features beyond the fundamental properties of options and forwards, introducing higher complexity.

Reporting Trades in the Equity Unlisted Market

Reporting requirements for unlisted trades differ by jurisdiction. Notably, in Ontario, investment dealers must report unlisted and unquoted equity trades via the Canadian Unlisted Board Inc.’s web-based system, as mandated by the Ontario Securities Act. Conversely, the rest of Canada lacks obligatory trade reporting for unlisted securities.

CSC® Exams Practice Questions

📚✨ CSC Exam Questions ✨📚

Welcome to the Knowledge Checkpoint! You'll find 10 carefully curated CSC exam practice questions designed to reinforce the key concepts covered. These questions will help you gauge your grasp of the material, identify areas that need further review, and ensure you're on the right track towards mastering the content for the Canadian Securities certification exams. Take your time, think critically, and use these quizzes as a tool to enhance your learning journey. 📘✨

Good luck!

## What is a key characteristic of dealer markets compared to auction markets? - [ ] Orders are entered in a centralized marketplace - [x] Market makers post bid-and-ask quotations via electronic platforms - [ ] All transactions are conducted in person - [ ] Dealers act exclusively as agents > **Explanation:** Dealer markets, unlike auction markets, involve market makers posting bid-and-ask quotations via electronic platforms and computer networks. Dealers typically act as principals. ## In dealer markets, which role do investment dealers typically assume? - [ ] Agents - [ ] Regulators - [x] Principals - [ ] Auditors > **Explanation:** Investment dealers generally act as principals in dealer markets, meaning they trade securities for their own accounts. ## What type of securities are predominantly sold through dealer markets? - [x] Bonds and debentures - [ ] Common stocks - [ ] Preferred shares - [ ] Exchange-traded funds (ETFs) > **Explanation:** Almost all bonds and debentures are sold through dealer markets, making them primary securities for this type of market. ## Dealer markets are also known as: - [ ] Listed markets - [x] Unlisted markets - [ ] Auction markets - [ ] Centralized markets > **Explanation:** Dealer markets are referred to as unlisted markets as the securities traded on them are not listed on organized exchanges. ## What is the main function of market makers in dealer markets? - [ ] To serve exclusively as intermediaries - [x] To quote their own bid and ask prices and hold an inventory of securities - [ ] To act as regulators - [ ] To list securities on stock exchanges > **Explanation:** Market makers quote their own bid and ask prices and hold an inventory of securities, contributing to market liquidity. ## How are trades conducted in the over-the-counter (OTC) derivatives market? - [ ] Through a centralized marketplace - [x] Via direct negotiations between large international financial institutions - [ ] By listing on a stock exchange - [ ] Only during standard trading hours > **Explanation:** OTC derivatives trades are conducted through direct negotiations between parties, typically large financial institutions, and the market operates 24 hours a day. ## What is one of the attractive features of OTC derivative products? - [ ] They must meet strict regulatory standards - [ ] They are simple and standardized - [x] They can be custom designed with special features - [ ] Limited trading hours > **Explanation:** OTC derivative products can be custom designed to meet the specific needs of the buyer and seller, often leading to more complex structures. ## In which province are investment dealers required to report trades of unlisted securities? - [ ] British Columbia - [x] Ontario - [ ] Alberta - [ ] Quebec > **Explanation:** In Ontario, investment dealers must report trades of unlisted securities through the Canadian Unlisted Board Inc.'s web-based system as per the Ontario Securities Act. ## Trading in unlisted equity markets typically offers: - [ ] Higher liquidity than listed securities - [x] Lower liquidity than listed securities - [ ] Equivalent liquidity to listed securities - [ ] Zero liquidity > **Explanation:** Unlisted equity markets generally offer lower liquidity compared to listed securities, making them more speculative. ## Which entities dominate the OTC derivatives market? - [ ] Individual investors - [x] Large international financial institutions like banks and investment dealers - [ ] Small brokerage firms - [ ] Organized exchanges > **Explanation:** The OTC derivatives market is primarily dominated by large international financial institutions such as banks and investment dealers.

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