City's Bernardo Silva and Mateo Kovacic both misfired in the shootout to put Madrid in the driving seat
After continuing their 100 percent start in the Champions League, Leicester's disappointing domestic form came back under scrutiny and they responded emphatically.
Leicester had created little until three minutes before halftime when Musa lashed home an unstoppable shot from Islam Slimani's set-up to open his account for the club.
Claudio Ranieri's side doubled their lead when Shinji Okazaki fired home in the 63rd minute after Danny Drinkwater's cross was only half cleared and Austrian defender Fuchs iced the cake with a thunderous third from 25 metres.
Palace grabbed a late consolation through Yohan Cabaye.