Factors Affecting Marketability of Municipal Bonds
Understanding what makes a municipal bond easy or hard to trade is essential for advising customers. A bond's marketability directly affects its liquidity and the price an investor can expect in the secondary market.
Marketability Factors
| Factor | Impact on Marketability |
|---|---|
| Credit rating | Higher ratings (AAA, AA) = more marketable; lower ratings = less liquid |
| Maturity | Shorter maturities are generally more marketable than longer maturities |
| Call features | Callable bonds are less marketable to investors who fear early redemption |
| Coupon (interest) rate | Bonds with market-rate coupons are more marketable than those with below-market coupons |
| Block size | Odd lots (less than $100,000) are harder to trade than round lots |
| Liquidity | Ability to sell quickly in the secondary market without a significant price concession |
| Dollar/yield price | Bonds priced at or near par are more marketable than deep-discount or high-premium bonds |
| Issuer name/reputation | Well-known issuers (New York, California) are more marketable than obscure small issuers |
| Credit enhancement | Bond insurance or letter of credit (LOC) backing increases marketability |
| Credit and liquidity support | Standby purchase agreements and remarketing arrangements improve liquidity |
| Denominations | Standard $5,000 denominations are more marketable; nonstandard denominations are harder to trade |
Think of it this way: The more "standard" a bond looks, the easier it is to trade. High rating, near-par price, market-rate coupon, well-known issuer, round lot: each of these makes a bond attractive to more buyers, which means tighter spreads and faster execution.
Exam Tip: Gotchas
- Odd lots (under $100,000 face value) trade at wider spreads, making them less marketable. Round lots are the standard trading unit.
- A 2% coupon in a 5% rate environment is hard to sell. Below-market coupon = deep discount = fewer interested buyers.
- Credit enhancement improves marketability even if the underlying issuer is weak. Bond insurance or an LOC effectively substitutes the insurer's credit quality for the issuer's.
- Call features hurt marketability because investors risk losing a favorable income stream to early redemption, especially when rates have fallen.