Municipal Bond Market: The Essentials of Municipal Bond Market Trading
Municipal bonds, otherwise known as state and local bonds are long-term debt instruments issued by local and state governments to finance expenditures on projects such as schools, roads, and other large projects. The issuances of these bonds are protected and monitored by layers of extensive rules and regulations to make sure that transaction in the municipal bond market are above water.
A very important feature of these bonds is that their interest payments are exempt from federal income tax and generally from state taxes in the issuing state. The biggest buyers of these securities are commercial banks with their high income tax rate. Commercial banks own over half the total outstanding amount. The next biggest group of holders of municipal bonds are the wealthy individuals in high income brackets followed by the insurance companies.
The municipal bond market is one of the biggest securities exchange. An approximated $2 trillion are on the hands of investors in this type of bond. Daily trading on municipal bonds amounts to an average of $11 billion daily. From the more than 50,000 state and local units that issues these bonds, there is an estimate of 2 million issuances. Some of these bonds are traded quickly while others – their owners waiting for the bonds to mature – stagnate for months.
Rules Governing Bond Trading
Municipal bonds are traded directly instead of on an organized exchange system. Banks and brokerage firms, which are registered with the Municipal Securities Rulemaking Board (MSRB), are the ones who buy and sell municipal bonds.
There are approximately 3,000 firms engaged in the selling and buying of municipal bonds. The rules followed on the trading of municipal bonds are formulated by the MSRB, subject to the oversight of the Securities and Exchange Commission. As of present, approximately 5.1 million households own municipal bonds in varying degrees. This ownership could be either through direct ownership of individual bonds or through investments in institutional groups such as bank trust accounts, mutual funds, and investments trust.
Prices of municipal bonds are determined on the basis of maturity, liquidity, quality, and yield. Of these four factors, the most significant is yield. For someone to invest on municipal bonds, it is critical to evaluate it first according to the comparative cost of alternatives available and to the merits of the transaction.
How Municipal Bonds Are Traded
The municipal bond market is just like any other market, albeit it exists theoretically only. Here, dealers compete with one another for probable customers on the basis of yield as well as bond performance. Every bond available for trading is priced, taking into consideration the following factors:
- Supply and demand for the bond
- Credibility of the bond’s issuer
- The bond’s prevailing interest level
- How often the bonds are traded
- Performance in the municipal bond market
- The availability of finding an investor willing to buy the bonds
- The bond’s maturity
- The frequency of evaluating the bond’s performance as assured by the dealer
The Securities Industry and Financial Markets Association (SIFMA) Municipal Swap Index was formerly known as the Bond Market Association Municipal Swap Index. The index was created out of the pressing need to have a uniform basis with which it will be accurately reflect the bond’s performance in the market.
In the creation of the index, many factors and variables were either rejected or utilized, following an extensive analyses on historical correlation. The index is calculated on a weekly basis, making sure that there are frequent updates on it but not too frequent as to render bond holders anxious, rendering trading worthless. Moreover, through the index, municipal bond market news and information are released to traders and issuers of the bond.