The Secondary Market

Secondary Market Structure

The municipal bond secondary market is where previously issued municipal bonds are bought and sold among investors. Unlike the stock market, which operates on centralized exchanges like the NYSE and Nasdaq, the municipal bond secondary market is primarily an over-the-counter (OTC) dealer market. This means that trades occur through a network of broker-dealers who negotiate directly with one another and with their customers, rather than through a centralized exchange.

The OTC nature of the municipal market has historically made it less transparent than the equity market. Municipal bond prices, trade volumes, and other market data were not readily available to the general public. However, significant regulatory initiatives over the past two decades have greatly improved transparency, most notably through the creation of EMMA and the implementation of trade reporting requirements.

There are over one million different municipal bond CUSIPs outstanding at any given time, compared to roughly 5,000 stocks on major exchanges. This enormous number of individual securities, combined with the fact that many bonds trade infrequently (some may not trade for weeks or months), makes the municipal market fundamentally different from the equity market. Many municipal bonds are purchased by investors who hold them until maturity, which reduces secondary market liquidity.

Dealer Trading

Municipal bond dealers trade in two capacities. When acting as a dealer (principal), the firm buys bonds for its own inventory and later sells them to customers or other dealers. The dealer's compensation is the markup (when selling from inventory) or markdown (when buying for inventory from a customer). When acting as a broker (agent), the firm arranges trades between buyers and sellers without taking ownership of the bonds, earning a commission for its services.

Quotations and Pricing

Municipal bond quotations in the secondary market can be expressed in two ways: on a yield basis or on a dollar price basis. Understanding both quoting conventions is essential for the Series 52 exam.

Yield Basis (Basis Quotes)

Most municipal bonds trading at or near par are quoted on a yield basis. A quote of "3.50" means the bond is priced to yield 3.50% to maturity (or to the call date if priced to the call). Yield-based quotes are the traditional convention in the municipal market and make it easy to compare bonds with different coupon rates and maturities on a common basis.

When a dealer quotes a bond on a yield basis, the actual dollar price must be calculated based on the coupon rate, maturity date, and yield. This calculation takes into account accrued interest and follows standard pricing conventions. Municipal bonds accrue interest on a 30/360 day-count basis (each month is assumed to have 30 days, and the year is 360 days), which differs from corporate bonds that also use 30/360 but from U.S. Treasury securities that use actual/actual day counts.

Dollar Price Basis

Some municipal bonds are quoted on a dollar price basis, expressed as a percentage of par value. A quote of "102" means the bond is priced at 102% of par, or $1,020 per $1,000 bond. Dollar price quotes are commonly used for bonds trading at a significant premium or discount to par, term bonds, and zero-coupon bonds.

Fair Pricing and Markups

MSRB Rule G-30 requires that the price charged by a dealer must be fair and reasonable, taking into account all relevant factors. There is no fixed percentage cap on markups, but the MSRB and FINRA consider several factors when evaluating fairness:

• The best judgment of the dealer as to the fair market value of the securities at the time of the transaction
• The expense involved in effecting the transaction
• The fact that the dealer is entitled to a profit
• The total dollar amount of the transaction
• The type of security (actively traded vs. thinly traded)
• The availability of the security in the market
• The price and yield at which the dealer acquired the security

EMMA and Price Transparency

The Electronic Municipal Market Access (EMMA) system is the MSRB's centralized platform for free public access to municipal securities information. EMMA (emma.msrb.org) provides investors and the general public with real-time trade data, official statements, continuing disclosure filings, and other important information about municipal bonds.

EMMA's Key Functions

• Trade Price Transparency: All municipal bond trades must be reported to the MSRB's Real-Time Transaction Reporting System (RTRS). Trade data, including price, yield, and par amount, is made available on EMMA within 15 minutes of the trade. This real-time transparency was a major improvement for the municipal market.
• Official Statements: Underwriters must submit official statements to EMMA. Investors can access these documents for free, providing essential disclosure information about bond issues.
• Continuing Disclosure: Issuers that have entered into continuing disclosure agreements (required under SEC Rule 15c2-12 for offerings over $1 million) must file annual financial information and event notices on EMMA. This ensures ongoing transparency even after the bonds are issued.
• Advance Refunding Documents: Information about refunded bonds, escrow deposit verification reports, and other refunding-related documents are available on EMMA.

Confirmation Requirements

MSRB Rule G-15 governs the content and delivery of customer confirmations for municipal bond transactions. The confirmation must include detailed information about the transaction, including:

• Trade date, settlement date, and capacity (principal or agent)
• Description of the security (issuer, coupon rate, maturity date, call features)
• Par value, price, yield (to maturity or to call, whichever is lower), and accrued interest
• CUSIP number
• Whether the bond is subject to AMT
• If acting as agent, the commission amount; if acting as principal, whether the firm's markup/markdown is disclosed
• Any special conditions (e.g., bond insurance, credit rating, sinking fund, pre-refunded status)

Municipal bond trades settle on a T+1 basis (one business day after the trade date), which is the same settlement cycle used for most other securities. This was changed from T+2 in 2024 as part of the SEC's shortened settlement cycle initiative.