- OTC contracts give more flexibility and offer scope for customization. This is correct but purchasing a portfolio of 'vanilla' products can achieve the same result in most cases, subject to market access and other constraints.
- No margin needs to be posted. This is incorrect. Open any ISDA contract and you notice provision for posting margin even in ordinary repo contracts!! Banks have got scared post Lehmann default and other Black swan events
- OTC has counterparty risk unlike exchange contracts. With the tendency to demand collateral/other funding for derivatives contract, this fact may stay only for interbank transactions/transactions with A+ rated counterparties-with others having to give some security. Also, this is mitigated(specially where cross banking relationships exist) by the right of setoff, from the perspective of the bank/FI.
Sunday, April 24, 2011
OTC and exchange traded derivatives-does any significant difference remain for clients?
Open a college financial textbook and you read the distinctions between OTC and exchange traded contract.I reproduce some of them below with my comments in italics.