What type of market structure do OTC markets use instead of centralized exchanges?

Decentralized dealer networks where securities trade directly between parties through market makers.

True or False: OTC markets have a physical trading floor like traditional stock exchanges.

False. OTC markets operate electronically or via telephone with no centralized physical location.

What is the difference between bid price and ask price in OTC markets?

Bid is what dealers pay to buy; ask is what they charge to sell.

Which OTC market tier has the highest quality standards and disclosure requirements?
A) OTCQB
B) Pink Market
C) OTCQX
D) Grey Market

C) OTCQX - requires high financial standards, ongoing disclosure, and annual verification.

Fill in the blank: Market makers profit from the _____ between bid and ask prices.

Spread

What happens when a dealer acts as principal in an OTC transaction?

The dealer trades from their own inventory, buying into and selling from their accounts.

True or False: OTCQB companies must maintain a minimum bid price of $0.10 per share.

False. OTCQB companies must maintain a minimum bid price of $0.01 per share.

Which regulatory body primarily oversees broker-dealers who participate in OTC markets?

FINRA (Financial Industry Regulatory Authority)

What are the four categories within the Pink Market tier?

Current Information, Limited Information, No Information, and Caveat Emptor.

Scenario: A dealer quotes '10.50 - 10.75, 5×3'. What does this mean?

Bid $10.50 for 500 shares, ask $10.75 for 300 shares.

What is the standard settlement period for most OTC equity trades?

T+2 (trade date plus two business days)

True or False: All corporate bonds trade on centralized exchanges rather than OTC markets.

False. Most corporate bonds trade OTC through dealer networks, not on exchanges.

What does DVP stand for in OTC settlement processes?

Delivery vs. Payment - securities delivered only against simultaneous payment.

Which type of risk occurs when market makers stop quoting prices for securities?
A) Credit risk
B) Liquidity risk
C) Settlement risk
D) Inflation risk

B) Liquidity risk - when market makers withdraw, liquidity can disappear entirely.

Fill in the blank: _____ transactions occur when broker-dealers act as agents for customers.

Agency

What information must appear on OTC trade confirmations regarding dealer capacity?

Whether the firm acted as principal or agent in the transaction.

True or False: The 5% markup policy is a strict ceiling that dealers cannot exceed.

False. It's a guideline; actual fairness depends on specific transaction circumstances.

What are American Depositary Receipts (ADRs) that commonly trade OTC?

Securities representing shares of foreign companies trading in U.S. markets.

Which market has no minimum financial standards or reporting requirements?
A) OTCQX
B) OTCQB
C) Pink Market
D) NASDAQ

C) Pink Market - the lowest tier with highest risk and lowest transparency.

What happens during a riskless principal transaction?

Dealer receives customer order, immediately executes offsetting transaction, then completes customer trade.

Fill in the blank: U.S. Treasury securities settle on a _____ basis.

T+1

True or False: OTC Markets Group is a regulatory authority like FINRA or SEC.

False. OTC Markets Group is a private company providing market infrastructure, not a regulator.

What causes wider bid-ask spreads in OTC markets compared to exchanges?

Lower liquidity, fewer market participants, and higher dealer risk from holding inventory.

Scenario: An investor wants to sell 10,000 shares of a Pink Market stock immediately. What risks do they face?

Wide spreads, limited liquidity, difficulty finding buyers, and significant price impact.

What is counterparty risk in OTC transactions?

Direct credit risk that one party may fail to fulfill transaction obligations.

Which OTC securities are backed by the full faith and credit of the U.S. government?
A) Fannie Mae bonds
B) Corporate bonds
C) Treasury securities
D) Municipal bonds

C) Treasury securities - government debt obligations with the strongest credit backing.

Fill in the blank: Municipal bonds are primarily regulated by the _____.

MSRB (Municipal Securities Rulemaking Board)

True or False: Penny stocks are defined as securities trading below $1 per share.

False. SEC defines penny stocks as equity securities trading below $5 per share.

What additional documentation is required before executing penny stock transactions?

Risk disclosure document and signed suitability statement from the customer.

What distinguishes Grey Market trading from other OTC market tiers?

No market maker quotes or company information; trading occurs through case-by-case negotiation.

Which system reports OTC corporate bond transactions for transparency?
A) EMMA
B) TRACE
C) OTC Link
D) EDGAR

B) TRACE (Trade Reporting and Compliance Engine) for corporate bond trade reporting.

Fill in the blank: Interest rate swaps involve exchanging _____ rate payments for _____ rate payments.

Fixed, floating (or vice versa)

True or False: Forward contracts can only settle through physical delivery of the underlying asset.

False. Forward contracts typically settle through physical delivery but cash settlement is possible.

What makes mortgage-backed securities subject to prepayment risk?

Homeowners may refinance or pay off mortgages early, affecting expected cash flows.

Scenario: A dealer has excess inventory in a particular bond. How might this affect their quotes?

They may lower ask prices to sell and reduce bid prices to discourage buying.

What is the inside market (NBBO) in OTC trading?

The highest bid price and lowest ask price among all market makers.

Which characteristic makes structured products like CDOs primarily trade OTC?
A) High liquidity
B) Standardized terms
C) Customization
D) Exchange listing requirements

C) Customization - complex, non-standardized terms require OTC dealer networks for trading.

Fill in the blank: Rule _____ governs broker-dealer quotation publication and information review requirements.

15c2-11

True or False: Interdealer brokers trade directly with retail customers in OTC markets.

False. Interdealer brokers facilitate trades only between market makers, not with retail customers.

What happens if both parties in an OTC trade fail to meet settlement obligations?

Creates fail to deliver (seller) and fail to receive (buyer), potentially resulting in penalties.

Why do most debt securities trade OTC instead of on exchanges?

Customized terms, infrequent trading, and institutional nature make dealer networks more suitable.