Commercial Paper (CP) is a short-term unsecured promissory note issued by corporations to finance their short-term liabilities. Unlike Bankers’ Acceptances (BAs), which are guaranteed by a bank, CP is not secured by any collateral, making its issuance more reliant on the issuing corporation’s creditworthiness. Typically, CP carries a maturity period ranging from a few days up to 270 days.
Types of Commercial Paper
Asset-backed Commercial Paper (ABCP)
This form of CP is backed by the issuing company’s assets, providing an added layer of security over traditional CP.
Traditional Commercial Paper
Standard CPs are not backed by collateral and rely solely on the issuer’s credit rating.
Key Characteristics
Unsecured
CP does not involve any collateral, differentiating it from secured short-term debt instruments.
Short-term Maturity
The maturity period for CP is usually short, ranging from a few days up to a maximum of 270 days.
Interest Rates
Interest rates on CP are generally lower than bank loans, but vary based on the creditworthiness of the issuing firm.
Denominations
CP is typically issued in large denominations, often exceeding $100,000.
Historical Context
Commercial Paper has been utilized since the 19th century as a means for corporations to meet short-term funding needs. Its popularity surged with the establishment of organized money markets, offering corporations an alternative to bank loans for short-term financing.
Applicability
Corporate Financing
CP is widely used by corporations to manage short-term liquidity needs, fund operations, and take advantage of investment opportunities.
Money Markets
CPs are commonly traded in money markets and are a significant component of the short-term financing market.
Examples
Company Issuing CP
A technology company issues $500,000 of Commercial Paper with a 90-day maturity at an interest rate of 2%. This CP is purchased by institutional investors seeking short-term yields.
Special Considerations
Credit Rating
The issuance and interest rates of CP are heavily influenced by the issuing corporation’s credit rating. A high credit rating usually results in lower interest rates.
Regulatory Limits
In the United States, the Securities Act of 1933 requires that CP must have a maturity period of no more than 270 days to be exempt from SEC registration.
Comparisons with Similar Instruments
Commercial Paper vs. Bankers’ Acceptances (BAs)
- Collateral: CP is unsecured, while BAs are secured by a bank’s acceptance.
- Issuance: CP is issued by corporations, whereas BAs are typically drawn on and accepted by banks.
Commercial Paper vs. Corporate Bonds
- Maturity: CP has a maturity of up to 270 days, while corporate bonds usually have longer maturities ranging from one year to several decades.
- Security: CP is unsecured, while corporate bonds may be either secured or unsecured.
Related Terms
- Promissory Note: A written promise to pay a specified amount of money at a specific future date, similar in nature to CP but can have longer terms and be secured.
- Money Market: A sector of the financial market where short-term securities, including CP, are traded.
- Credit Rating: An assessment of the creditworthiness of a borrower, including corporations issuing CP.
Frequently Asked Questions (FAQs)
What is the primary risk associated with Commercial Paper?
The primary risk is credit risk, given that CP is unsecured and relies on the issuer’s creditworthiness.
Who can issue Commercial Paper?
Typically, only corporations with high credit ratings can issue CP due to the lack of collateral.
How is Commercial Paper purchased?
CP is commonly purchased by institutional investors in the money market, including mutual funds, banks, and insurance companies.
References
- Securities and Exchange Commission. “The Investor’s Advocate: How the SEC Protects Investors, Maintains Market Integrity, and Facilitates Capital Formation.”
- Federal Reserve. “Understanding Commercial Paper.”
- Investopedia. “Commercial Paper.”
Summary
Commercial Paper (CP) is a crucial financial instrument for corporate short-term funding. Its unsecured nature underscores the importance of issuer credit ratings, offering a flexible, authoritative means for corporations to manage liquidity. CP stands as a testament to the dynamic nature of short-term financial markets, reflecting both historical practices and modern financial strategies.
