What is commercial paper’
Commercial paper is unsecured short-term debt instruments issued by a Corporation, typically for financing accounts receivable and inventories and meet short-term obligations. Terms on commercial paper rarely range more than 270 days. Commercial paper usually is issued at a discount from face value and reflects the prevailing levels of market interest rates.
Penetration ‘business papers’
Commercial paper is not usually backed by any form of collateral, making this in the form of unsecured debt. As a result, only firms with high quality debt ratings will easily find buyers without having to offer a substantial discount (higher cost) for the debt issue. Because commercial paper issued by large institutions, the denomination of commercial paper are significant, usually $100,000 or more. Other corporations, financial institutions, rich people and the money market funds, as a rule, buyers of commercial paper.
The advantages of commercial paper
One of the main benefits of commercial paper is that it does not need to be registered in the Commission on securities and exchange Commission (sec) as long as it Matures before nine months, or 270 days, making it a very cost effective way of financing. Although maturities can go for as long as 270 days before coming within the purview of the Commission, the maturity dates for commercial paper averaged about 30 days, rarely reaching this threshold. The revenues from this type of financing can only be used on current assets or inventory, and cannot be used on fixed assets such as new plant, without sec involvement.
Commercial paper during the financial crisis
The securities market plays a big role in the financial crisis that began in 2007. As investors began to doubt the financial stability and liquidity of companies such as Lehman brothers, commercial paper market froze and companies were no longer able to access simple and affordable financing. Another effect of commercial paper freeze of the market, some money market funds, substantial investments in commercial paper, “breaking the buck.” This meant that affected the funds the net asset value of less than $1, reflecting a decline in the value of their outstanding commercial paper issued by companies suspected of financial health.
Example of commercial paper
Example of commercial paper is when the retail firm is looking for short term Finance new inventory for the upcoming holiday season. The firm needs$ 10 million, and it offers investors a 10.1 In nominal value of commercial paper million dollars in exchange for $ 10 million in cash at prevailing interest rates. In fact, it would not be paying interest of 0.1 million $after the repayment of commercial paper in exchange for $ 10 million in cash, equivalent interest rate of 1%. This interest rate may be adjusted at the time depends on the number of days in commercial paper is outstanding.
Want to know more? Read Introduction To Commercial Paper.