What are over-the-counter (OTC) derivatives?

Over-the-counter (OTC) derivatives are indeed contracts tailored to the specific needs of the parties involved. This flexibility allows the negotiating parties to customize various aspects of the derivatives contract, such as the terms, conditions, and underlying assets, to better suit their individual risk management or investment strategies. This customization is a key characteristic that differentiates OTC derivatives from those traded on formal exchanges, where standardized contracts are utilized to facilitate trading and liquidity.

The ability to create bespoke contracts makes OTC derivatives versatile, accommodating unique requirements that cannot be met by standardized instruments. This feature is especially important for entities looking to hedge specific risks or for investors seeking to achieve tailored financial outcomes.