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Commercial Paper Characteristics

Trading in commercial paper.

• Rates and Pricing
• Benefits and Risks

The Bottom Line

• Guide to Mutual Funds

An Introduction to Commercial Paper

Daniel Rathburn is an editor at Investopedia who works on tax, accounting, regulatory, and cryptocurrency content.

Commercial paper is a short-term debt instrument issued by corporations to finance inventory, accounts payable, payroll, and other short-term liabilities.

The world of fixed-income securities can be divided into two main categories: capital markets and money markets. Capital markets consist of securities with maturities of more than 270 days, while money markets consist of securities with maturities of 270 days or less, the latter of which commercial paper falls into.

Key Takeaways

• Commercial paper is a common form of unsecured, short-term debt issued by a corporation.
• Commercial paper is typically issued for the financing of payroll, accounts payable, inventories, and meeting other short-term liabilities.
• Maturities on most commercial paper range from a few weeks to months.
• Commercial paper is usually issued at a discount from face value and reflects prevailing market interest rates.

Commercial paper is an unsecured form of promissory note that pays a fixed rate of interest. It is typically issued by large banks or corporations to cover short-term receivables and meet short-term financial obligations, such as funding for a new project.

As with any other type of bond or debt instrument, the issuing entity offers the paper assuming that it will be in a position to pay both interest and principal by maturity. It is seldom used as a funding vehicle for longer-term obligations because other alternatives are better suited for that purpose.

The commercial paper provides a convenient financing method because it allows issuers to avoid the hurdles and expense of applying for and securing continuous business loans, and the Securities and Exchange Commission (SEC) does not require securities that trade in the money market to be registered. It is usually offered at a discount with maturities that can range from one to 270 days, although most issues mature in one to six months.

History of Commercial Paper

Commercial paper was first introduced over 100 years ago when New York merchants began to sell their short-term obligations to dealers who acted as intermediaries. These dealers would purchase the notes at a discount from their par value and then pass them on to banks or other investors. The borrower would then repay the investor an amount equal to the par value of the note.

Marcus Goldman of Goldman Sachs was the first dealer in the money market to purchase commercial paper, and his company became one of the biggest commercial paper dealers in America following the Civil War. The Federal Reserve also began trading commercial paper along with Treasury bills from that time until World War II to raise or lower the level of monetary reserves circulating among banks.

After the war, commercial paper began to be issued by a growing number of companies, and eventually, it became the premier debt instrument in the money market. Much of this growth was facilitated by the rise of the consumer credit industry, as many credit card issuers would provide cardholder facilities and services to merchants using money generated from commercial paper. The card issuers would then purchase the receivables placed on the cards by customers from these merchants (and make a substantial profit on the spread).

A debate raged in the 1980s about whether banks were violating the Banking Act of 1933 by underwriting commercial paper since it is not classified as a bond by the SEC. Today commercial paper stands as the chief source of short-term financing for investment-grade issuers along with commercial loans and is still used extensively in the credit card industry.

Commercial paper is usually low cost, low risk, highly liquid, has higher yields, and is widely accepted.

Commercial Paper Markets

Commercial paper has traditionally been issued and traded among institutions in denominations of $100,000, with notes exceeding this amount available in $1,000 increments. Financial conglomerates such as investment firms, banks, and mutual funds have historically been the chief buyers in this market, and a limited secondary market for this paper exists within the banking industry.

Wealthy individual investors have also historically been able to access commercial paper offerings through a private placement . The market took a severe hit when Lehman Brothers declared bankruptcy in 2008, and new rules and restrictions on the type and amount of commercial paper that could be held inside money market mutual funds were instituted as a result. Nevertheless, these instruments are becoming increasingly available to retail investors through online outlets sponsored by financial subsidiaries.

Commercial paper usually pays a higher rate of interest than guaranteed instruments, and the rates tend to rise along with national economic growth. Some financial institutions even allow their customers to write checks and make transfers online with commercial paper fund accounts in the same manner as a cash or money market account.

However, investors need to be aware that these notes are not FDIC-insured . They are backed solely by the financial strength of the issuer in the same manner as any other type of corporate bond or debenture. Standard &Poor’s and Moody’s both rate commercial paper on a regular basis using the same rating system as for corporate bonds, with AAA and Aaa being their highest respective ratings.

As with any other type of debt investment, commercial paper offerings with lower ratings pay correspondingly higher rates of interest. But there is no junk market available, as commercial paper can only be offered by investment-grade companies.

Commercial Paper Defaults

As a practical matter, the Issuing and Paying Agent, or IPA, is responsible for reporting the commercial paper issuer's default to investors and any involved exchange commissions.

Since commercial paper is unsecured, there is very little recourse for investors who hold defaulted paper, except for calling in any other obligations or selling any held stock of the company. In fact, a large default can actually scare the entire commercial paper market. Many commercial paper issuers purchase insurance as a form of backup.

Common types of commercial paper include drafts, promissory notes, certificates of deposit, letters of credit, structured notes, registered notes, and receivable-backed commercial paper.

It is possible for small retail investors to purchase commercial paper, although there are several restrictions that make it more difficult. Most commercial paper is sold and resold to institutional investors, such as large financial institutions, hedge funds, and multinational corporations.

A retail investor would need access to very large amounts of capital to buy and own commercial paper; otherwise, indirect investment is possible through mutual funds, exchange-traded funds (ETFs), or a money market account administered and held at a depository institution.

Factors such as regulatory costs, the scale of investable capital, and physical access to the capital markets can make it very difficult for an individual or retail investor to buy and own commercial paper.

For example, commercial paper is typically sold in round lots totaling $100,000. This threshold in itself makes buying commercial paper generally exclusive to institutional investors and wealthy individuals.

Further, broker-dealers issuing commercial paper on behalf of a client have pre-existing relationships with institutional buyers that make the market efficient through large purchases of primary offerings. They would not be likely to look to individual investors as a source of capital to fund the transaction.

Commercial Paper Rates and Pricing

The Federal Reserve Board posts the current rates being paid by commercial paper on its website. The FRB also publishes the rates of AA-rated financial and non-financial commercial paper in its H.15 Statistical Release daily weekdays Monday through Friday at 4:15 p.m.

The data used for this publication are taken from the Depository Trust & Clearing Corporation (DTCC), and the rates are calculated based on the estimated relationship between the coupon rates of new issues and their maturities.

Additional information on rates and trading volumes is available each day for the previous day’s activity. Figures for each outstanding commercial paper issue are also available at the close of business every Wednesday and on the last business day of every month.

Types of Commercial Paper

There are generally four types of commercial paper: promissory notes, drafts, checks, and certificates of deposit (CDs).

• Promissory notes : A promissory note is a written promise to pay a certain sum of money to a specified person or entity on a specific date or on demand, and is the most common form of commercial paper. Promissory notes are often used in commercial transactions as a way for one party to borrow money from another party.
• Drafts : A draft is a written order directing a bank to pay a specified sum of money to a designated person or entity. There are two types of drafts: sight drafts, which are payable when presented to the bank, and time drafts, which are payable at a later date.
• Checks : A check is a written order directing a bank to pay a specified sum of money to a designated person or entity. Checks can be either personal checks, which are issued by individuals, or cashier's checks, which are issued by banks.
• Certificates of deposit (CDs): A certificate of deposit is a type of time deposit offered by banks and other financial institutions. It is a promise to pay the depositor a fixed sum of money on a specific date in the future. CDs typically have fixed maturities and fixed interest rates.

Benefits and Risks of Commercial Paper

There are several advantages to using commercial paper as a source of funding. One advantage is speed; commercial paper can be issued quickly, making it a good option for companies that need to raise funds on short notice.

Another advantage is flexibility; companies can use commercial paper to raise funds for a variety of purposes, including working capital, financing inventory, and refinancing debt. Additionally, commercial paper tends to have lower costs than other types of short-term borrowing, such as bank loans and can help companies demonstrate their financial stability and creditworthiness to potential investors, potentially improving their overall credit rating.

However, there are also some risks to consider when using commercial paper. These include credit risk, where the issuer of the commercial paper may default on its payment obligations; interest rate risk, where the value of commercial paper may fluctuate in response to changes in interest rates; liquidity risk, where commercial paper may not be easily traded or sold; and regulatory risk, where commercial paper is not subject to the same level of regulatory oversight as other types of securities, increasing the risk of fraud or other misconduct by issuers.

Can be issued quickly

Used for a variety of purposes

Interest rates typically lower than those on other types of short-term borrowing

Potential for credit enhancement

Liquidity risk

Regulatory risk

Interest rate risk

Credit risk

Example of Commercial Paper

Say that a company needs to raise funds to finance a new product line. The company has a strong credit rating and a good track record of financial performance, so it decided to issue commercial paper to raise the necessary capital.

It works with a financial institution to issue $10 million in commercial paper with a maturity of 180 days and an interest rate of 2%. The company uses the proceeds from the sale of the paper to fund the development and production of the new product line. As the paper matures, the company repays the investors the principal amount plus the agreed-upon interest.

This process allows the company to quickly and efficiently raise the funds it needs to finance its new product line without having to take on additional debt or equity.

Why Is Commercial Paper Used?

Commercial paper is typically issued by companies to raise funds to meet their short-term financial obligations. This can include using the funds for working capital, refinancing debt, funding capital expenditures, and meeting other financial commitments. The goal of issuing commercial paper is to provide companies with a quick, cost-effective, and timely way to raise the funds they need to meet their financial obligations and grow their business.

Who Issues Commercial Paper?

Commercial paper is typically issued by large, financially stable companies with good credit ratings. These may include corporations, financial institutions, and other businesses. Companies that issue commercial paper are looking to raise funds to meet their short-term financial obligations and may use the proceeds from the sale of the paper for a variety of purposes, including working capital, financing inventory, and refinancing debt.

What Is the Difference Between Commercial Paper and Corporate Bonds?

Commercial paper and corporate bonds are both types of debt securities that are issued by companies to raise funds. However, there are several key differences between the two:

• Maturities : Commercial paper has a short-term maturity, typically ranging from a few days to 270 days. Corporate bonds, on the other hand, have longer maturities, typically ranging from five to 30 years.
• Credit ratings : Commercial paper is typically issued by financially stable companies with high credit ratings, while corporate bonds may be issued by companies with a wide range of credit ratings.
• Interest rates : The interest rates on commercial paper are generally lower than those on corporate bonds, reflecting the lower level of risk associated with the paper.
• Registration : Commercial paper is not registered with the Securities and Exchange Commission (SEC) and is therefore not subject to the same level of regulatory oversight as corporate bonds.
• Trading : Commercial paper is typically traded over-the-counter (OTC), while corporate bonds are often traded on exchanges in addition to the OTC market.
• Collateral : Some commercial paper may be backed by collateral, such as inventory or accounts receivable, while corporate bonds are not typically collateralized.

Commercial paper is a way for companies to raise short-term capital to fund their ongoing operations and overhead. It is also becoming increasingly available to retail investors from many outlets. Those who seek higher yields will likely find these instruments appealing due to their superior returns with modest risk.

S&P Global. " Intro to Credit Ratings ."

Moody's. " Rating Scale and Definition ," Page 1.

S&P Global. " Issue Credit Ratings ."

Board of Governors of the Federal Reserve System. " Commercial Paper Rates and Outstanding Summary, Commercial Paper Rates ."

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What is Commercial Paper?

Risks of commercial paper, real-world example, additional resouces, commercial paper.

A short-term, unsecured debt instrument with a duration of 1-270 days

Commercial paper refers to a short-term, unsecured debt obligation that is issued by financial institutions and large corporations as an alternative to costlier methods of funding. It is a money market instrument that generally comes with a maturity of up to 270 days.

Commercial paper is sold at a discount to its face value to compensate the investor, as opposed to paying cash interest like a typical debt security. In other words, the difference between the face value at maturity and the investor’s discounted purchase price is the investor’s “profit.” The need for commercial paper often arises due to corporations facing a short-term need to cover expenses.

Commercial paper is often referred to as an unsecured promissory note , as the security is not supported by anything other than the issuer’s promise to repay the face value at the maturity date specified on the note.

• Commercial paper is a short-term, unsecured debt instrument with a duration of 1-270 days.
• Financial institutions and large corporations are the main issuers of commercial paper because they have high credit ratings. There is trust in the market that they will repay unsecured promissory notes of this nature.
• Commercial paper is usually sold at a discount to its face value and is a cheaper alternative to other forms of borrowing.

1. Credit rating

It is important to note that due to the promissory nature of the commercial paper, only large corporations with high credit ratings will be able to sell the instrument at a reasonable rate. Such corporations are what is colloquially defined as “blue-chip companies” and are the only ones that enjoy the option of issuing such debt instruments without collateral backing.

If a smaller organization were to try to issue commercial paper, it is quite likely that there would not be enough trust on the part of investors to buy the securities. The credit risk, which can be defined as the likelihood that a borrower is unable to repay the loan, will be too high for smaller organizations, and there will be no market for this type of issue.

2. Liquidity

Another potential risk of commercial paper, although less relevant than with other, longer-term debt instruments, is that of liquidity. Liquidity generally refers to the ability of a security to be converted into cash at a price that reflects its fair value. That is to say, liquidity reflects how easily a security can be bought or sold in the market.

In the case of commercial paper, liquidity is less of a concern than credit (default) risk as the debt matures quite rapidly, leaving little room for additional trading on secondary markets . For this reason, such secondary markets are quite small, despite the issue being one of the most used money market debt instruments.

A real-world example would be that a large corporation, take Microsoft Corp. , would like additional low-cost funding to launch a new research and development program. At this point, the company’s leadership would weigh their options and possibly conclude that commercial paper is a more attractive source of capital than taking out a line of credit with a financial institution.

In such a situation, Microsoft will be leveraging its status as an established business with a high credit rating to issue an unsecured debt instrument, such as commercial paper, and in the process lowering its cost of capital. `

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Commercial Paper

What is Commercial Paper?

Commercial paper is an unsecured and discounted promissory note issued to finance the short-term credit needs of large institutional buyers. Banks, corporations, and foreign governments commonly use this type of funding.

How Does Commercial Paper Work?

Exempt from SEC registration, commercial paper generally matures in a short period of time and usually does not exist for more than 270 days. The average maturity of commercial paper is between 30 and 35 days. The average investment is about $100,000, but some commercial paper investments are made in multiples of $1 million or more. It is not uncommon for issuers to adjust the amounts and/or the maturities of commercial paper to suit the investment needs of a particular buyer or group of buyers.

Commercial paper is usually issued by companies with very high credit ratings . Because of this, and because it generally matures in a very short period of time, commercial paper tends to be a very low-risk investment. Most commercial paper is assessed by more than one rating agency. The four primary agencies are: Moody's , Standard & Poor's, Fitch, and Duff & Phelps.

Although commercial paper is occasionally issued as an interest-bearing note, it typically trades at a discount to its par value . In other words, investors usually purchase commercial paper below par and then receive its face value at maturity. The discount, or the difference between the purchase price and the face value of the note, is the interest received on the investment. All commercial paper interest rates are quoted on a discounted basis .

Why Does Commercial Paper Matter?

Commercial paper is issued by a wide variety of domestic and foreign firms, including financial companies, banks, and industrial firms.

Major investors in commercial paper include money market mutual funds and commercial bank trust departments. These large institutional investors often prefer the cost savings inherent in using commercial paper instead of traditional bank loans .

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Commercial Paper

It is an unsecured promissory note with a fixed amount of interest issued to achieve short-term requirements

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What Is Commercial Paper?

• Advantages Of Commercial Paper
• Risks Of Commercial Paper
• How Commercial Paper Works
• Types Of Commercial Paper

Commercial Paper FAQs

Commercial paper is an unsecured promissory note frequently issued by banks, companies, and other financial organizations with a fixed amount of interest to achieve their financing short-term requirements.

Large corporations issue (sell) commercial paper in the commercial paper market to raise money for short-term debt obligations (such as payroll), and it is backed only by the issuing bank's or company's promise to pay the face amount on the note's maturity date.

In most cases, the face value of the commercial paper is discounted when it is issued, and the difference between the two amounts constitutes the interest that the investor will receive.

It is often issued at a discount to its face value and matures between a few days to a few months, with the most common maturity time ranging from 30 to 270 days.

Money market funds , institutional investors, corporations, and individual investors who seek low-risk, short-term investments are examples of short-term paper investors. 

It has lower interest rates than other kinds of borrowing since organizations frequently issue it with good credit ratings. 

It also allows issuers to readily convert their short-term assets into cash, while investors can swap their short-term debt paper holdings in the secondary market . This liquidity provision provides flexibility and allows investors to access cash if needed swiftly.

The issuance is governed by regulations, which ensures openness and investor protection. The Securities and Exchange Commission ( SEC ) oversees its offerings in the United States, imposing disclosure obligations on issuing corporations. 

These obligations include disclosing information regarding the issuer's financial health , activities, and potential risks so investors can make informed judgments.

The interest rates are often lower than other debt instruments, reflecting the issuer' s perceived creditworthiness . As a result, it is an enticing investment option for people seeking to conserve wealth while earning a return.

Investors must carefully examine creditworthiness and market circumstances to avoid risks and achieve optimal profits. Commercial paper is critical to preserving business financial stability and promoting economic growth .

Key Takeaways

Commercial paper is an unsecured promissory note issued by banks and companies for short-term funding needs. Typically issued at a discount, it matures between a few days to a few months, attracting low-risk, short-term investors.

It offers a cost-effective source of short-term capital, flexibility in borrowing amount and maturity period, quick access to cash, and diversification of funding sources.

Risks include credit, liquidity, market, regulatory, and reinvestment risks and should be carefully considered by investors.

It is issued through underwriters, involving credit rating, documentation, marketing, and distribution. Investors purchase paper, and upon maturity, the issuer repays face value; secondary market trading is available.

Types of commercial paper include unsecured, asset-backed, financial, non-financial, foreign, seasoned, and tax-exempt, each catering to different preferences and needs.

Advantages of Commercial Paper

Let us take a brief look at the different benefits of issuing the paper below:

For issuing entities

• Cost-Effectiveness: It is frequently a more cost-effective source of short-term capital than other kinds of borrowing, such as bank loans or lines of credit. The interest rates are often lower, especially for issuers with excellent credit ratings. This can lead to huge cost reductions for businesses. 
• Flexibility: It provides flexibility in terms of the amount borrowed and the maturity period. The size and duration of the paper issuance can be tailored to the issuer's individual funding needs, allowing them to align their financing with their short-term cash flow requirements . 
• Financing Diversification: Companies can diversify their funding sources by issuing paper. Relying solely on bank loans or lines of credit may expose enterprises to concentration risk if the banking sector is disrupted or credit conditions change. 
• Issuance Ease: This is an alternate way to raise financing from a broader group of investors. Compared to obtaining a regular bank loan, the paper approval and issuance process is often shorter and requires less documentation. 
• Access to Liquidity: It enables organizations to access cash more quickly, which can be critical in meeting immediate working capital requirements or capitalizing on short-term business possibilities.

For investors

• Accessibility: It typically matures in a few days to many months. This appeals to short-term investors because it allows them to swiftly reinvest their assets at potentially higher rates if interest rates rise.
• Higher Yields: While the paper provides low-risk returns, the yields are often greater when compared to other low-risk short-term assets such as government securities or  money market accounts . Investors can earn a decent return while protecting their wealth.
• Low Risk: Well-established corporations typically issue it with good credit ratings. This lowers the default risk, making it a reasonably safe investment alternative, especially compared to longer-term debt instruments.
• Liquid Investment: It is generally considered a liquid investment. Investors can sell their paper holdings on the secondary market before maturity, giving them liquidity and the opportunity to retrieve their cash if necessary.
• Investment Diversification: It allows investors to diversify their investment portfolios. They can invest in those papers issued by various companies and industries, spreading their risk across different issuers and thereby improving their portfolio's overall risk-reward profile.

Risks of Commercial Paper

While commercial paper has many advantages, it also has certain risks. Credit risk is a substantial risk since it exposes investors to the chance of nonpayment or delayed reimbursement if the issuing firm defaults. 

To mitigate this risk, investors carefully evaluate issuers' creditworthiness , considering credit ratings provided by respected rating agencies. Let us take a look at some of the risks that commercial paper carries:

• Liquidity Risk: While it is normally considered a liquid investment, there may be times when the secondary market becomes illiquid. Investors may experience difficulties selling the paper before maturity if there is a dearth of buyers or a loss of confidence in the market.
• Issuer-Specific Risks: The risks connected with an issuer's financial health , industry-specific issues, or management actions can impact the paper's creditworthiness. Changes in the issuer's credit rating or impression of its creditworthiness might impact market demand and pricing for the paper.
• Credit Risk: It is an unsecured debt instrument, which means there is no security backing the obligation. The creditworthiness of the issuer becomes critical in determining the risk of default. If the issuer's financial status deteriorates or there is a substantial economic downturn, the issuer may fail on principle and interest payments .
• Market Risk : Market conditions can influence pricing. Interest rate fluctuations can have an effect on the price and yield of paper. If interest rates rise, the value of the existing paper may fall, potentially resulting in losses for investors who desire to sell before maturity.
• Regulatory Risk: It is subject to regulatory scrutiny and compliance obligations. Changes in regulations or the introduction of new regulations may impact the issuance or trading of the paper, thereby influencing its liquidity and value.
• Reinvestment Risk: Investors who rely on paper income face the risk of reinvesting the proceeds at lower interest rates if the paper matures during a period of dropping interest rates.

How Commercial Paper works

Commercial paper is created through a simple procedure that involves issuers, investors, and financial intermediaries. 

Here is a detailed description of how the short-term debt paper works.

• Issuance and Terms: Through the underwriter, the issuer decides the amount of paper to be issued and the terms, including the maturity date, interest rate, and other pertinent components. Based on the issuer's creditworthiness and current market conditions, the underwriter supports the issuer in calculating the appropriate interest rate.
•  Credit Rating and Documentation: The credit rating evaluates the issuer's creditworthiness and informs investors about the risk of the paper. The issuer prepares the relevant documentation, such as a prospectus that explains the issuer's financial position, operations, and terms.
• Marketing and distribution: The underwriter uses its network and skills to attract buyers and develop demand for the paper. The distribution may occur through a private placement to a small group of investors or through public offers registered with the appropriate regulatory authorities.
• Investor Purchase: Investors send their buy orders to the underwriter or their approved broker after they are satisfied. Investors can specify the face value and maturity date of the paper they want to purchase.
• Issuance and Settlement: The underwriter completes the issuance process by accepting purchase orders and confirming the distribution of the paper to investors. The issuer then distributes them to investors, either electronically or as physical certificates.
• Interest Payments and Maturity: The issuer pays periodic interest to investors depending on the agreed-upon interest rate and schedule. When the paper matures, the issuer repays the face value to the investors.
• Secondary Market Trading: Investors who want to sell their short-term debt paper before maturity can do so in the secondary market. The secondary market provides liquidity and allows investors to buy or sell the paper to other market participants at a price different from the initial acquisition.

Types of Commercial Paper

Commercial paper comes in various forms to meet the demands and preferences of issuers and investors. 

Here are a few examples of commercial paper:

• Unsecured Commercial Paper: The most frequent sort of paper in which the issuer provides no specific collateral or security for the debt. Investors evaluate the risk associated with the paper based on the issuer's creditworthiness and reputation.
• Asset-Backed Commercial Paper (ABCP): It is backed by a single asset or a group of underlying assets, such as accounts receivable , inventory, or mortgage loans . The cash flows generated by these assets are used to secure them. ABCP gives investors greater security by tying the paper to tangible assets.
• Financial Commercial Paper: It is issued by financial entities such as banks, investment businesses, or insurance organizations. These institutions employ that paper to raise short-term capital to meet operational needs, finance trading activities, or support lending operations.
• Non-Financial Commercial Paper: Firms in various industries other than the financial industry issue these. Companies utilize nonfinancial short-term debt papers to meet short-term liquidity needs, finance working capital, or fund specific projects.
• Foreign Commercial Paper: It is issued by entities located in countries other than the investor's home country. Investors may seek foreign commercial paper exposure to diversify their investment portfolio or to capitalize on specific market opportunities.
• Seasoned Commercial Paper: It is a  commercial paper that has had one or more rollovers or renewals. It is more established and may have a track record that investors can use to gauge risk.
• Tax-Exempt Commercial Paper: It is issued by municipal bodies like states, cities, or public agencies and is exempt from certain taxes like the federal income tax . Investors looking for tax breaks may be interested in tax-exempt commercial paper.

It involves issuers borrowing funds from investors for a set time, ranging from 270 days. When the securities mature, the issuers reimburse the principal amount to investors, together with interest.

Corporations of various sizes, creditworthiness , and financial organizations such as banks and insurance companies can issue those papers.

Credit risk (issuer failing on payment), market risk ( interest rate variations affecting prices), liquidity risk (lack of buyers in the secondary market ), and issuer-specific risks ( financial health and industry-specific issues) are all concerns associated with commercial paper .

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What Is Commercial Paper?

How commercial paper works, history of commercial paper, commercial paper markets, commercial paper vs. bonds, rates for commercial paper, trading commercial paper.

Commercial paper is a form of unsecured debt that allows companies to bypass a traditional lender, according to the SEC. Companies may issue commercial paper when they need to raise money. Commercial paper is a short-term debt security, so the money raised is often used for immediate expenses like inventory and payroll.

Commercial paper can be issued for terms as short as 1 day, and up to 270 days, although the average maturity is 30 days . Commercial paper usually comes in increments of $100,000, so in most cases, only institutional investors and high-net-worth individuals can afford to invest in it.

Commercial paper is an unsecured promissory note usually issued by major banks or corporations. The entity that issues the commercial paper assumes it will be able to pay the interest and principal by the time it matures.

Tip: Commercial paper is a type of unsecured loan that enables companies to access the capital markets without having to list securities or go through the process of securing a business loan.

Companies issue commercial paper because it enables them to avoid the expense and process of applying for business loans. Additionally, the Securities and Exchange Commission doesn't require money market securities, which include commercial paper, to be registered.

Most commercial paper is issued at a discount to the face value and matures within 30 days. Entities issue commercial paper when they need to pay for short-term financial liabilities like accounts payable, inventory, or payroll.

When companies repay their commercial paper, they also make an interest payment at the time they pay off the principal.

The use of commercial paper began more than 150 years ago in the U.S. Retailers found they could offload debt that was due in less than a year by issuing notes at less than face value to brokers. Individual investors and institutions such as banks bought the commercial paper from the middlemen, and at the end of the term, they were repaid by the retailers at the notes' full value.

Marcus Goldman of Goldman Sachs was the first dealer to buy commercial paper, and the firm became one of the largest dealers of commercial paper in the U.S. after the Civil War. The Federal Reserve also started trading commercial paper alongside Treasury bills around the time of the Civil War until World War II to increase or decrease the amount of monetary reserves held by banks.

After World War II, a growing number of companies started to issue commercial paper, and eventually, it became the money market's most popular debt instrument. The consumer credit industry has facilitated much of the growth in the commercial paper market.

Many card issuers provided cardholder facilities to merchants using the money they generated from commercial paper. They then bought the receivables the merchants placed on the cards, turning a significant profit on the spread.

More recently, commercial paper has become investment-grade issuers' main source of short-term financing next to commercial loans. The use of commercial paper is still widespread in the credit card industry.

Banks and corporations typically issue commercial paper in denominations of $100,000, with notes higher than that coming in $1,000 increments. The main buyers are banks, investment firms, and mutual funds , although there is a limited secondary market in the banking industry.

Commercial paper is not FDIC-insured, so there is no guarantee that the money will be paid back. The notes are backed only by the issuer's financial strength in the same way as other types of debentures or corporate bonds .

Credit rating agencies Standard and Poor's and Moody's rate commercial paper regularly using the same rating system they use for corporate bonds. Respectively, their highest ratings are AAA and Aaa. Commercial paper with lower ratings pays higher interest rates, just as with any other type of debt instrument.

However, there is no junk market like there is with bonds because only investment-grade companies can issue commercial paper. For this reason, the risk of default on commercial paper is fairly low. The lowest credit rating for commercial paper is D.

Two primary differences for commercial paper as compared to bonds relate to the term and the payment of interest.

• Commercial paper is issued from 1 day to 270 days, versus 1 year to 30 years for bonds.
• Bonds require regular interest payments, whereas commercial paper interest is paid only at maturity.

Investors can find the current rates on commercial paper by checking the Federal Reserve Board . Investors can also check the FRB's H.15 Statistical Release Monday through Friday at 4:15 p.m. Eastern for the rates of AA-rated financial and non-financial commercial paper.

The rates are based on data from the Depository Trust & Clearing Corporation (( DTCC )), and they are calculated using the estimated relationship between the coupon rates of new issues and their maturity dates. The DTCC exchanges commercial paper on behalf of buyers and sellers and acts as a central securities depository.

Retail investors can trade commercial paper, but they usually don't because they are issued in $100,000 increments. To efficiently trade in the commercial paper market, investors should have large amounts of capital.

Additional potential issues for retail investors who want to trade commercial paper include regulatory costs, the amount of investable capital, and physical access to the capital markets. Many broker-dealers that issue commercial paper on behalf of clients have relationships with institutional investors, which increases efficiency in the market but makes it more difficult for retail investors to buy.

To avoid these problems, retail investors can invest indirectly through mutual funds, exchange-traded funds , or money market accounts that buy commercial paper.

This article was written by

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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Commercial Paper: Understanding its Role in Short-Term Financing

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Commercial Paper Definition

Commercial paper refers to a short-term, unsecured promissory note or debt instrument issued by large corporations to obtain funds to meet short-term debt obligations. It is typically used for the financing of payroll, accounts payable and inventories, and its maturity usually ranges from a few days to 270 days.

Characteristics of Commercial Paper

Commercial paper, due to its unique nature and purpose, has certain distinguishable traits that you should be aware of.

Short-Term Nature

One of the most prevalent characteristics of commercial paper is its short-term nature. These financial instruments typically have a maturity period of less than 270 days. This is because they are designed to meet short-term funding needs and are not meant to be a long-term debt instrument. This limited timeframe often results in less risk for investors, making it a popular choice for those seeking a temporary parking place for their funds.

Unsecured Status

Commercial paper is often unsecured, meaning there are no assets or collateral backing the promise of payment. If the issuing company goes bankrupt or becomes insolvent, there is a risk that the paper would become worthless and investors would lose their money. Despite this risk, the high creditworthiness of issuing companies often overcomes investor concerns about the unsecured nature of the paper.

High Credit Rating

Another common feature of commercial paper is that it's often issued by companies with a high credit rating. The participants in this market are usually financially strong corporations with good credit records. Because the quality of the issuing company plays a pivotal role in the investor's decision, commercial paper is often issued by corporations with top-tier credit ratings.

Role in Corporate Financing and Liquidity Management

Commercial paper plays a key role in corporate financing and liquidity management. Companies often use this instrument to finance their short-term operational needs such as payroll, inventory, and accounts receivables. It's a more cost-effective alternative to bank loans, allowing corporations to meet their immediate financial obligations without tying up their long-term credit lines. On the liquidity management front, commercial paper provides corporations with a tool to balance their cash flow and maintain necessary operational liquidity.

Commercial paper's short-term nature, unsecured status, typically high credit rating, and key role in corporate financing and liquidity management, make it a pivotal instrument in meeting the immediate financial needs of corporations, while presenting a relatively low-risk, short-term investment opportunity for investors.

Issuing Commercial Paper

Before a company issues commercial paper, it first needs to decide whether commercial paper is the right instrument for it. One significant factor that companies often consider is the current interest rate. Compared to long-term financing options, commercial paper will typically have a lower cost due to its shorter maturity period; however, if interest rates are high, the company might still find commercial paper to be expensive. Thus, a future projection of interest rates also comes into play when making a decision.

Another crucial factor is the company's credit rating. Commercial paper is not backed by collateral, which means investors rely entirely on the issuer's credibility. Companies with higher credit ratings can issue commercial paper at a lower cost compared to those with lower ratings since the risk perceived by investors is lesser. Therefore, credit ratings substantially affect the decision to issue commercial paper.

If a company decides to issue commercial paper, it follows a certain procedure. The process generally involves the following steps:

Step-by-Step Process of Issuing Commercial Paper

1. meeting with a financial institution.

The first step for the company is to meet with a financial institution. The institution serves as a dealer by helping to issue and sell the commercial paper. It facilitates the issuance process and provides the necessary liquidity to the company.

2. Preparing the Paper

After the agreement with the financial institution is established, the company prepares the commercial paper. It entails laying down the details such as the maturity period, interest rate, and size of the issue. The company may decide to issue the paper on a discount basis, which means it sells the paper for less than its face value, or on an interest-bearing basis where the company pays the interest at the end of the maturity period.

3. Making the Paper Available

The commercial paper is made available to the potential investors through the dealer. The investors may include institutional investors, corporations, or even individuals, with institutional investors being the most common.

4. Settlement

Once the investor purchases the paper, the funds are transferred to the company, and the investor receives the commercial paper. The company then uses these funds to meet its short-term needs.

The commercial paper issuance process is indeed a strategic decision for companies requiring short-term funding, helping them capitalize on lower borrowing costs compared to traditional means of short-term financing. However, it's crucial to evaluate the factors contributing to this decision and make informed choices.

Buyers of Commercial Paper

Primarily, it is the institutional investors that are typical buyers of commercial papers. Institutional investors can be entities such as pension funds, mutual funds, insurance companies, or commercial banks, to name just a few. Their interest in commercial paper stems largely from the advantages these debt instruments have to offer.

Institutional Investors and Commercial Paper

Institutional investors, due to their financial clout and their need for safe, short-term investments, are perfectly suited to be buyers of commercial paper. These debt instruments offer a way for them to park their funds for a short duration (usually less than 270 days), while they strategize on other long-term investment opportunities.

Low-Risk Income

One of the primary attractions of commercial paper for institutional investors is that it is considered low risk. This is because commercial paper is generally issued by corporations with high credit ratings, meaning the risk of default is typically low. Not to forget that these are unsecured loans, thus, investors rely on the corporation's financial strength and reputation for assurance.

The return on commercial paper, while not as high as more risky investments, is generally better than that offered by government bonds of similar maturity. Therefore, buying commercial paper provides institutional investors with a source of steady and comparatively safe income.

Diversification

Commercial paper also offers a means of portfolio diversification. Diversification is a key strategy in risk management, and buying commercial paper can help institutional investors spread their risk across a variety of assets. Unlike other investments, commercial paper is not correlated with stock market performance, which means its value may remain stable even when the stock market is experiencing turbulence. This makes it an attractive opportunity to balance the risk inherent in other investments.

Quick Liquidity

Commercial papers typically have short maturity periods that allows investors to retain a level of liquidity. This ensures investment flexibility as the institutional investors can quickly turn these papers into cash without significant loss if the need arises.

In conclusion, the features of commercial paper—low risk, consistent returns, diversification benefits, and liquidity—are what primarily draw institutional investors to it. These factors make commercial paper a valuable and strategic tool for these investors.

Risks Associated with Commercial Paper

Credit risk.

Commercial paper is widely considered a safe investment due to its typically high credit ratings and short maturity. However, there is still a level of credit risk involved, especially for investors. Credit risk pertains to the possibility that the issuing entity will default or fail to fulfill their financial obligations, resulting in loss of principal or interest amount for the investor. During the 2008 financial crisis, some high-profile firms that issued commercial paper defaulted owing to poor financial health, leaving investors in a lurch.

Interest Rate Risk

Interest rate risk is more so a concern for issuers than investors. If interest rates rise after a firm has issued commercial paper, the cost of issuing new commercial paper could also increase. In such a situation, the issuer has to pay a higher rate of interest on new issuances. For existing investors, however, a rise in interest rates could potentially increase their yield.

The 2008 financial crisis did elevate this risk, as emergency measures were enacted to combat the economic downturn, leading to fluctuating interest rates.

Liquidity Risk

Finally, liquidity risk is also a vital concern in the realm of commercial paper. This risk refers to the fear that an investor may not be able to buy or sell their holdings in the commercial paper quickly without incurring a substantial loss in value.

Such a situation was evident during the 2008 financial crisis when liquidity in the commercial paper market shrunk rapidly as many investors panicked and tried to sell their holdings, causing a sudden and substantial drop in their value. It also made it harder for issuers to re-issue their commercial paper efficiently, thus disrupting their short-term financing.

While commercial paper generally is a useful financial instrument for both issuers and investors, the financial crisis of 2008 illustrated how these innate risks could materialize and impact all stakeholders involved. Therefore, it is crucial to comprehend these risks before engaging in any commercial paper transactions.

Commercial Paper vs. Other Short-term Instruments

When comparing commercial paper with other short-term debt instruments such as treasury bills and short-term bonds, it's important to look at key factors like yield, credit quality, and liquidity.

Commercial Paper: Commercial paper generally has a higher yield compared to other short-term instruments. This is because commercial paper incorporates a higher level of risk compared to government-backed securities, leading the issuer to offer a higher return to attract investors.

Treasury Bills: The yield on Treasury Bills, or T-Bills, is typically lower than that of commercial paper. T-Bills are considered among the safest investments since they're backed by the full faith and credit of the U.S. government, and therefore, they offer a lower return.

Short-Term Bonds: Similar to T-Bills, short-term bonds have lower yields than commercial paper. Corporate short-term bonds may have slightly higher yields as the risk is usually higher than for T-Bills, but still less than commercial paper.

Credit Quality

Commercial Paper: Generally, only firms with a high credit rating issue commercial paper. However, since commercial paper is unsecured, meaning not backed by collateral, it's usually subject to a greater risk than other short-term instruments, hence a higher yield.

Treasury Bills: As mentioned previously, T-bills are backed by the U.S. government, making them a very safe investment with high credit quality.

Short-Term Bonds: The credit quality of short-term bonds can vary greatly depending on the issuer. Bonds issued by reputable corporations or government entities are typically safer and consequently have lower yields than those from less established issuers.

Commercial Paper: Commercial paper is generally less liquid than T-Bills and short-term bonds. While primary dealers are able to monetize commercial paper, it can be harder for individual investors to sell their holdings before maturity.

Treasury Bills: T-Bills are highly liquid. They have a robust secondary market where investors can buy and sell their positions without much difficulty.

Short-Term Bonds: Liquidity of short-term bonds depends on their issuer and the size of the issue. Bonds from large, reputable issuers are more likely to have a greater degree of liquidity.

In conclusion, while commercial paper, treasury bills, and short-term bonds are all means of short-term financing, they each possess different characteristics in terms of yield, credit quality, and liquidity. It's important for investors to consider these factors when choosing which instrument is the best fit for their investment portfolio.

Commercial Paper and the Financial Market

In the context of the broader financial market, commercial paper tends to hold a significant position. As a form of short-term unsecured borrowing, it serves as a crucial funding source for many corporations. Particularly for the institutions with high credit ratings, issuing commercial paper often becomes a cost-effective way to cater to their short-term liquidity needs.

How Changes in the Commercial Paper Market Act as an Economic Indicator

The commercial paper market is closely watched by economists and financial market participants due to its potential function as an economic indicator. Fluctuations in the commercial paper market can reflect broader economic trends.

Impact on Interest Rates

The volume of commercial paper issuance tends to rise when interest rates are low. This is because companies can borrow at relatively low costs, making commercial paper a more attractive option compared to long-term debt. Conversely, if the volume of issuance drops, it may suggest that companies are finding it more expensive to borrow, implying an upward movement in interest rates.

Reflection of Credit Conditions

The state of the commercial paper market can also signal changes in credit conditions. If companies are issuing less commercial paper, it may mean they are struggling to find buyers, which could suggest tighter credit conditions. This could be because investors are wary of corporations' creditworthiness, either because of issues specific to certain companies or because of broader economic concerns.

Indication of Economic Health

Another way commercial paper offers insights into economic health lies in its maturity structure. When nervousness pervades the market, investors may avoid commercial paper with longer maturities, favoring the relative safety of shorter maturities. An increased skew towards shorter maturity commercial paper could be an indication of financial-market stress, hinting at a softer economic outlook.

These points underscore how changes in the commercial paper market can offer valuable signals about broader economic and financial trends. Yet, it is critical to remember that while analyzing patterns in commercial paper can provide useful chapters of a bigger economic story, they are just one part of the narrative, with many moving pieces influencing overall market dynamics.

Implications of Commercial Paper in CSR and Sustainability

From a Corporate Social Responsibility (CSR) and sustainability standpoint, the issuance of commercial paper carries significant implications. Organisations that champion values such as environmental stewardship, social welfare and economic equality often use commercial paper to further bolster their commitment towards such benchmarks.

###Green Commercial Paper

Of particular interest is the concept of green commercial paper. This novel financial instrument is closely aligned with environmental conservation goals and green economy transitions. As part of sustainability financial strategies, organisations utilise the funds raised through green commercial paper to finance eco-friendly projects and initiatives. Examples may include, but are not limited to, renewable energy projects, waste management solutions, or initiatives aimed at reducing a company's carbon footprint.

Furthermore, this short-term financing solution constitutes an attractive proposition for impact investors. These investors seek the dual-advantage of profitable returns and positive social/environmental outcomes – a criterion that green commercial paper ably fulfils.

###CSR and Stakeholder Engagement

Another key consideration in the nexus of commercial paper and CSR revolves around stakeholder engagement. As stakeholders become more aware and mindful of an organisation's environmental and social practices, they're more likely to show a preference for those thatfinance their activities through sustainable means, like commercial paper.

Given this, organizations issuing commercial paper often enjoy enhanced reputation, augmented customer loyalty, and even potential marketing advantages. On the other hand, companies also need to ensure that they uphold their CSR commitments. A failure to do so can result in reputational damage and lost stakeholder trust, impacting the credibility and tradability of their commercial paper.

###Regulatory Factors

Lastly, regulatory bodies and frameworks that emphasize sustainable finance are also encouraging organizations to incorporate herald economic instruments such as commercial paper into their financial strategies. One prominent example is the European Union’s classification system for green investments, or 'taxonomy', which categorises economic activities based on their environmental impact.

In conclusion, the issuance of commercial paper, particularly green commercial paper, can help organizations align with CSR and sustainability financial strategies. However, it is vital for them to sincerely commit to and implement their sustainability goals to enjoy the full spectrum of benefits from commercial paper.

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Commercial paper

Commercial paper is a short-term, unsecured promissory note issued by corporations to finance their immediate operational needs such as inventory and receivables. It is typically issued at a discount from face value and reflects prevailing market interest rates.

Related terms

Corporate Bonds : Long-term debt instruments issued by corporations to finance their operations, usually with a fixed interest rate.

Treasury Bills : Short-term government securities issued at a discount from the face value and mature in one year or less, offering a secure investment option.

Liquidity : The ease with which an asset can be converted into cash without significantly affecting its value, crucial for meeting short-term financial obligations

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• What Is Commercial Paper

What is Commercial Paper? Definition, Types

Meaning of commercial paper.

Commercial paper is an unsecured, short period debt tool issued by a company, usually for the finance and inventories and temporary liabilities. The maturities in this paper do not last longer than 270 days. These papers are like a promissory note allotted at a huge cost and exchangeable between the All-India Financial Institutions (FIs) and Primary Dealers (PDs).

Most of the commercial paper investors are from the banking sector, individuals, corporate and incorporated companies, Non-Resident Indians (NRIs) and Foreign Institutional Investors (FIIs), etc. However, FII can only invest according to the limit outlined by the Securities and Exchange Board of India (SEBI)

In India, commercial paper is a short-term unsecured promissory note issued by the Primary Dealers (PDs) and the All-India Financial Institutions (FIs) for a short period of 90 days to 364 days.

Related link:

• Marketing vs Branding
•   Functions of capital market

Commercial Paper in India

On 27th March 1989, commercial paper in India was introduced by RBI in the Indian money market. It was initially recommended by Vaghul working Group on the basis of the following points.

• The registration of commercial papers should only be granted to companies having Rs. 5 cores and above net worth with excellent dividend payment record.
• The market should follow the CAS discipline. The RBI should manage the paper amount, entry of the market, and total quantum which can be upgraded in a year.
• No limitation on the commercial paper market apart from the least size of the note. However, the size of one issue and each lot should not be less than Rs. 1 crore and Rs. 5 lakhs respectively.
• It should be eliminated from the provision of insecure advances in the state of banks.
• The company using commercial paper should have minimum 5 cores as net worth, a debt ratio maximum of 105, a debt servicing ratio closer to 2, current ratio minimum 1033, and should be recorded on the stock exchange.
• The paper can be made in terms of interest or at a discount rate to face value.
• It should not be compelled to stamp duty while issuing and transferring.

Do you know?   Top 10 Difference Between Money Market And Capital Market

Features of Commercial Paper

Few distinct features are:

• It is a short-term money market tool, including a promissory note and a set maturity.
• It acts as an evidence certificate of unsecured debt.
• It is subscribed at a discount rate and can be issued in an interest-bearing application.
• The issuer guarantees the buyer to pay a fixed amount in future in terms of liquid cash and no assets.
• A company can directly issue the paper to investors, or it can be done through banks/dealer banks.

Quick link: The  difference between Primary Market and Secondary Market

Types of Commercial Paper

According to the Uniform Commercial Code (UCC), commercial papers are divided into four different types.

• Draft – It is written guidance by an individual to another and to pay a stipulated sum to a third party.
• Check – It is a unique draft where the drawee is a bank.
• Note – Here, an individual is promised to pay another individual or bank a particular amount.
• Certificates of Deposit – In this type, a bank confirms the receipt of deposit.

According to security, there are two types of commercial papers

• Unsecured Commercial Papers – These are traditional papers and allotted without any security.
• Secured Commercial Papers – It is also known as Asset-Backed Commercial Papers (ABCP) and assured by other financial assets.

Students might also want to check:   What is Stock Exchange?

Advantages of Commercial Paper

• Contributes Funds – It contributes extra funds as the cost of the paper to the issuing company is cheaper than the loans of the commercial bank.
• Flexible – It has a high liquidity value and flexible maturity range giving it extra flexibility.
• Reliable – It is highly reliable and does not have any limiting condition.
• Save Money – On commercial paper, companies can save extra cash and earn a good return.
• Lasting Source of Funds – Maturity range can be customised according to the firm’s requirement, and matured papers can be paid by selling the new commercial paper.

Commercial Paper Formula

The formula for estimation discounted price of a commercial paper.

Yield = (Face value – Price)/ (price x no of days to maturity) X 365 X 100

Commercial Paper Example

Calculate the interest yield of the following commercial paper:

Brokerage = 3% of ₹500,000 = ₹15,000

Net Sale Price = ₹490,000 – ₹15,000 = ₹ 475,000

Yield = [(Face Value – Sale Price)/Sale Price] * (360/Maturity Period) * 100

= (5,00,000 – 4,75,000)/4,75,000 * (360/100) * 100

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Commercial Paper

By Majid Kazi |

January 6, 2021

What is Commercial Paper?

Commercial paper (CP) is a short-term note issued by corporations to raise funds. CP is an IOU or a document that acknowledges debt owed and serves as a promise to pay back the amount owed within a specified period. Commercial paper issued directly by companies typically has no security or collateral. As a result, only companies with good credit ratings can issue CP.

Key Learning Points

• Commercial papers (CPs) are a form of very short term traded public debt used by corporations to meet their short-term funding needs. Corporate commercial paper is typically unsecuritized
• In recent years Asset Backed Commercial Paper (ABCP) has become popular, but ACBP is normally issued by financial institutions
• The majority of commercial paper is issued for a very short-term period – usually measured in days (sometimes the term is overnight)
• The funds raised through commercial paper by non-financial corporations are typically used for immediate needs where cash is needed to meet short term obligations such as working capital funding
• Unlike bonds, commercial paper does not offer regular interest or coupon payments. CPs are usually issued for less than their face value or ‘at a discount’. Investors receive the full face value upon maturity
• Corporations issuing commercial paper typically need to have a very high credit rating, and also be issuing regularly into the market. They are typically very large companies

Commercial Paper Explained

Commercial paper is a form of debt to the issuer meaning it is an amount of money borrowed on the condition that it is repaid at a later date. The agreement almost always includes interest payments too. The commercial paper market is often referred to as the ‘money market’.

Commercial paper is just one of many different types of debt products available to companies in need of financing. The products can be grouped into four categories depending on whether they are due to be repaid within or over twelve months at inception, and whether they are traded in the public securities markets or are created by a direct relationship between the borrower and lender.

Commercial paper discounts and yields are calculated using a specific yearly day count convention. In the United States the day count convention for interest calculations is usually 360 days in a year.

Commercial papers are one form of a debt instrument. Here are some of its features:

Short-term Debt Instrument

Commercial paper is an unsecured form of public debt raised by issuing securities into the financial markets. The vast majority of commercial paper are issued for a very short term maturities (often overnight). Most commercial paper is issued for maturities below 270 days which avoids a specific SEC registration greatly increasing the cost of the issue.

CPs are reported as a current liability in the borrower’s balance sheet. Normally companies will ‘roll over’ their commercial paper programs financing at least some of the commercial paper repaid with new commercial paper.

If a corporation issues commercial paper it often will have a revolving credit facility ‘back stop’ in the event it can’t refinance its commercial paper in the market.

Uses of Funds Raised through CPs

Companies use the funds raised through commercial paper for their short-term funding needs such as accounts payable, inventory, and for financing seasonal working capital needs. Financial institutions and banks are big issuers of commercial paper and using it to support short-term funding of financial assets.

Commercial Paper vs. Bonds

Unlike some bonds, commercial paper does not offer multiple interest payments to investors. Commercial paper is usually issued for less than their face value, known as issuing at a discount. Investors receive the full face value upon maturity. Also, commercial paper has short maturities, unlike bonds that usually have maturities of more than 1 year.

Finding Commercial Paper in the Financial Statements

Here is a snapshot from the 2018 annual report of Honeywell International. The company’s balance sheet includes commercial paper in the current liabilities section.

Honeywell International, Inc. – Annual report 2018

In the section on “Liquidity and Capital Resources”, the company has mentioned commercial paper as a source of liquidity. It uses its commercial paper program for general corporate purposes and for financing acquisitions. The company adds its ability to raise funds through commercial paper is affected by its credit ratings.

Example: Commercial Paper

Here is some information from the website of Deutsche Telekom AG. The company has mentioned commercial paper as one of its sources of debt financing.

Deutsche Telekom AG -Investor relations, information on debt financing

This example highlights another application of commercial paper. The company clearly mentions that it does not use CPs to meet its short-term liquidity needs. Instead, it uses CPs as a source of financing to reduce its interest costs as CPs are a cheaper source of funding compared to their existing credit lines. This makes sense as typically interest rates for CPs are lower than lending rates charged by banks.

Example: Calculating interest from the discount

Commercial paper is quoted using a discount yield, which just means the % discount the paper is issued at. Below is the calculation to calculate the discount yield assuming a 360 day count:

The face value is the amount repaid at maturity (after 90 days in this case). The issue price is the amount given to the issuer by the investor. The discount yield is calculated by taking the discount in $s and dividing by the face value and then grossing up to a 360-day period from 90 days. The 360-day convention is from the days when calculations were done on slide rules rather than computers.

Example: Converting between a discount yield and a yield comparable to a bond

Comparing the cost of commercial paper to bond financing requires us to convert the discount yield to a normal yield and often to a 365 day basis to make the cost comparable to other sources of financing.

The face value is the amount repaid at maturity (after 30 days in this case). The discount yield is calculated using the methodology in the prior example.

We can calculate the issue price by taking the discount yield and converting it to a 30 day basis and the multiplying by the face value to calculate the discount and then deduct that from the issue price.

Next we calculate the bond equivalent yield, on a 365 basis in this case, by taking the amount of the discount and dividing by the issue price, and then grossing that up to a 365 day year.

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Key takeaways

• Commercial paper is a form of short-term financing for companies to cover working capital and other immediate needs, such as paying salaries, buying inventories, or paying suppliers.
• The paper is usually – but not always – sold at a discount to the issue price, and the full amount is repaid at maturity.
• As such, the yield is derived from the difference between the paper's discounted issue price and the face value at maturity.
• Institutional investors and high net worth individuals are traditional buyers of commercial paper, which is usually issued in tranches of US$100,000 or more.

What is commercial paper?

Commercial paper is a way for companies to raise money to cover short-term liabilities without relying on the banking system . The company issues commercial paper for tenors between one to six months to cover immediate expenses, like staff salaries, buying inventories, or paying suppliers.

The debt is unsecured because it is not backed by any of the company’s assets. Thus, the lender must rely on the reputation of the company and/or the investment grade credit rating it receives (if any) from rating agencies, like Standard & Poor’s and Moody’s, as assurance that the debt will be repaid.

The paper is usually – but not always – issued at a discount to its face value (the full amount the paper is worth) and receives the face value back when the debt matures. Thus, the investor's rate of return is equivalent to the difference between the face value and the discounted amount.

What are the advantages of investing in commercial paper?

Low  Risk – Commercial paper, though unsecured, is considered a low risk investment because generally only reputable and creditworthy companies may issue commercial paper.

Short Tenor – Commercial paper is short-term in nature and can be a useful place for investors to place cash that won’t be needed for the next few months. It also usually pays a higher interest rate than fixed deposits at banks.

Disadvantages:

Unsecured Debt : The investor has limited recourse if the company defaults and fails to make good on the debt. Thus the investor needs to make sure the company is in good financial health. In practice, commercial paper is usually issued by companies with strong creditworthiness so defaults are rare.

Who can invest in commercial paper?

Commercial paper has traditionally been issued and traded among institutions in denominations of US$100,000 or more, and has usually been taken up by institutional investors, very high net worth individuals, and money market funds.

ADDX democratizes commercial paper by making it available to investors for as little as S$10,000 to invest in primary offerings and as little as S$100 to trade in it.

To qualify as an ADDX investor, you need to meet one or more of the following conditions:

•Yearly income of at least S$300,000 or

•Net financial assets of at least S$1,000,000 or

•Net total assets of at least S$2,000,000

The Bottom Line

Commercial paper is a way for companies to raise money to cover short-term liabilities without relying on the banking system . It can be an attractive option for investors looking for low risk, short term investments.

ADDX is your entry to private market investing. It is a proprietary platform that lets you invest from USD 5,000 in private equity, private credit, hedge funds, commercial paper and more. ADDX is regulated by the Monetary Authority of Singapore (MAS) and is open to all non-US accredited and institutional investors.

Learn more about ADDX here or sign up for an account to start your alternative investment journey.

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Board of Governors of the Federal Reserve System

The Federal Reserve, the central bank of the United States, provides the nation with a safe, flexible, and stable monetary and financial system.

Commercial Paper Rates and Outstanding Summary

• Volume Statistics
• Outstanding
• Maturity Distribution
• Announcements
• Technical Q&As

About Commercial Paper RSS Data Download

Commercial paper (CP) consists of short-term, promissory notes issued primarily by corporations. Maturities range up to 270 days but average about 30 days. Many companies use CP to raise cash needed for current transactions, and many find it to be a lower-cost alternative to bank loans.

The Federal Reserve Board disseminates information on CP primarily through its World Wide Web site. In addition, the Board publishes one-, two-, and three-month rates on AA nonfinancial and AA financial CP weekly in its H.15 Statistical Release .

The Federal Reserve Board's CP release is derived from data supplied by The Depository Trust & Clearing Corporation (DTCC), a national clearinghouse for the settlement of securities trades and a custodian for securities. DTCC performs these functions for almost all activity in the domestic CP market. The Federal Reserve Board only considers maturities of 270 days or less. CP is exempt from SEC registration if its maturity does not exceed 270 days.

Data on CP issuance rates and volumes typically are updated daily and typically posted with a one-day lag. Data on CP outstanding usually are available as of the close of business each Wednesday and as of the last business day of the month; these data are also posted with a one-day lag. The daily CP release will usually be available at 1:00 p.m. EST. However, the Federal Reserve Board makes no guarantee regarding the timing of the daily CP release. This policy is subject to change at any time without notice.

Rate Calculations

To calculate CP interest rate indexes, the Federal Reserve Board uses DTCC's data for certain trades to estimate a relation between interest rates on the traded securities and their maturities. In this calculation, the trades represent sales of CP by dealers or direct issuers to investors (that is, the offer side) and are weighted according to the face value of the CP so that larger trades have a greater effect on the resulting index. With the relation between interest rates and maturities established, the reported interest rates represent the estimated interest rates for the specified maturities.

Interest rates calculated through the process described above are a statistical aggregation of numerous data reflecting many trades for different issuers, maturities, and so forth. Accordingly, the reported interest rates purport to reflect activity in certain segments of the market, but they may not equal interest rates for any specific trade. As with other statistical processes, this one is designed to minimize the difference between the interest rates at which actual trades occur and the estimated interest rates.

CP trades included in the calculation are chosen according to the specifications listed in the table below. Data to assess CP trades relative to these criteria are updated daily from numerous publicly available sources. Standard Industrial Classification (SIC) code classifications are taken from the Securities and Exchange Commission (SEC) Directory of Companies Required to File Annual Reports with the SEC. When an issuer's primary SIC code is not reported in the SEC directory, the primary SIC code reported in the issuer's financial reports is used; otherwise, SIC codes are determined upon consultation with the Office of Management and Budget's Standard Industrial Classification Manual or its Supplement.

For a discussion of econometric techniques for fitting the term structure of interest rates, including bibliographic information, see, for example, William S. Cleveland, 1979, "Robust Locally Weighted Regression and Smoothing Scatterplots," Journal of the American Statistical Association , 74, 829-36, or William S. Cleveland, Susan J. Devlin, and Eric Grosse, 1988, "Regression by Local Fitting," Journal of Econometrics , 37, 87-114.

Criteria for Calculation CP Interest Rate Indexes

Criteria Considered for All CP Interest Rate Indexes

• November 5, 2008: Clarification of Criteria Considered for Commercial Paper Rates
• June 18, 2007: Change to Credit Rating Agencies Considered

Outstanding Calculations

To calculate CP outstanding levels, the Federal Reserve Board uses DTCC's weekly and monthly CP outstandings data. CP outstanding levels are aggregates of all individual CP outstandings. The individual CP outstandings included in the calculation of the various levels are chosen according to data from numerous publicly available sources.

Seasonally adjusted outstanding levels are calculated using the Bell Labs seasonal adjustment method. For more information on the Bell Labs seasonal adjustment method see Cleveland, Devlin, and Terpenning, "The SABL Seasonal and Calendar Adjustment Procedures," Time Series Analysis: Theory and Practice 1 .

Tier Levels

Definitions of CP tiers used in calculations of outstanding levels for the Board’s CP release are based on ratings for short-term obligations from the nationally recognized statistical ratings organizations (NRSROs). A tier-1 security is a security that carries the highest rating ("1") for short-term obligations from at least two NRSROs. A tier-2 security is a security that carries one of the two highest ratings ("1" or "2") for short-term obligations from at least two NRSROs and that is not a tier-1 security. The sum of tier-1 and tier-2 securities will not add up to the total because some securities are not tier-1 or tier-2.

CP issues that would be in a given tier are excluded when (1) the issuer's credit ratings are under review and (2) a one-notch upgrade or downgrade would result in the issue no longer meeting the tier level credit rating requirement. Similarly, CP issues that would not be in given tier are included when (1) the issuer's credit ratings are under review and (2) a one-notch upgrade or downgrade would result in the issue meeting the tier level credit rating requirement.

Major Change to Outstanding Calculations (April 10, 2006)

On April 10, 2006, the Federal Reserve Board made major changes to its CP outstanding calculations. New outstanding categories were added, some existing category definitions were modified, and current and historical CP issuer information was updated.

The historical data for the new outstanding structure contains data for January 2001 through the most recently completed month. The historical data for the old outstanding structure contains data for January 1991 through March 2006. The historical data for both structures are available through the Federal Reserve Board's Data Download Program (DDP) . Please be aware that similarly named categories from both outstanding structures should not be viewed as equivalent.

• Total outstanding is the sum of nonfinancial, financial, asset-backed, and other (unknown) outstandings. Prior to April 10, asset-backed was considered to be a subcategory of financial and other (unknown) was not included in total outstanding. Other (unknown) is defined as outstanding CP issuers for which no SIC code could be determined.
• Nonfinancial outstanding is the sum of domestic, foreign, and other (unknown) nonfinancial outstanding. Other (unknown) nonfinancial outstanding is defined as nonfinancial outstanding CP by issuers for which no domicile could be determined.
• Financial outstanding is the sum of domestic, foreign, and other (unknown) financial outstanding. Other (unknown) financial outstanding is defined as financial outstanding CP by issuers for which no domicile could be determined.
• Asset-backed outstanding is no longer a subcategory of financial outstanding. Financial outstanding and all its subcategories no longer include asset-backed outstanding.
• Financial domestic outstanding is the sum of U.S owned, foreign bank parent, foreign nonbank parent, and other (unknown) financial domestic outstandings. Other (unknown) financial domestic outstanding is defined as financial domestic outstanding by issuers for which ownership could not be determined.
• Outstandings are calculated from issuance with maturity of 270 days or less.

Revisions to outstandings, based on updated issuer information, are made on a continuous basis without any notification. When revisions are sufficiently large, an announcement will be posted to the Announcements page of the CP release .

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• DOI: 10.56201/ijebm.v10.no3.2024.pg15.30
• Corpus ID: 270363127

Work-Life Balance Practices and Employee Commitment of Commercial Banks in Rivers State

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The Influence of Digital Finance on the Marketing Management of Commercial Banks under the Support of Mobile Social Network

9 Pages Posted: 26 Aug 2024

Lyceum of the Philippines University

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Date Written: May 15, 2024

The business model, application technology, and service scene of digital financial marketing business management of commercial banks should be transformed into digital form, and a digital and mobile digital financial marketing product service model should be formed to improve the marketing management effect. This should be done against the backdrop of digital finance and mobile social networks. This paper first discusses the fundamentals of commercial bank marketing management and the digital financial model of mobile social networks to examine the impact of digital and mobile marketing management on commercial banks. Second, it is suggested that mobile social networks and digital finance work together to better serve the needs of commercial banks' marketing services and operations. To that end, a mechanism model of digital finance for commercial banks' marketing management is implemented with the aid of mobile social networks. Finally, this paper examines the frequency with which commercial banks sell their service platforms to clients through the mobile social networks and the activities of digital finance in this area. According to the findings, commercial banks' mobile digital financial marketing has a low service rate but a significant number of active users. Mobile social networks and digital financial marketing tools that push financial products in accordance with consumer preferences can increase the effectiveness of marketing management. 

Keywords: Digital finance, mobile social network, commercial bank, marketing management, user activity

Suggested Citation: Suggested Citation

Can Huang (Contact Author)

Lyceum of the philippines university ( email ), do you have a job opening that you would like to promote on ssrn, paper statistics, related ejournals, interorganizational networks & organizational behavior ejournal.

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