Commercial papers are unsecured, short-term debt obligations issued by a Corporation, often for financing short-term liabilities and reserves. Meanwhile, Treasury bills (t-bills) are short – term debt with the support of the U.S. government with a maturity of up to one year. Funds raised from the sale of t-bills, is designed to support various community projects such as building schools and roads.
Why Do Commercial Bills Have Higher Yields
The reason that commercial bills have higher yields than Treasury bills, this is due to the different quality of each loan account type. The credit rating of the company issuing the bill gives investors an idea of the likelihood that they will be paid in full. Federal government debt (t-bills) is considered the highest credit rating in the market due to its size and ability to raise funds through taxes.
On the other hand, a company that issues commercial paper do not have the same ability to generate cash flow because it does not have the same power over consumers that the government over the electorate. In other words, commercial bills and t-bills differ in the quality of credit agencies that issue them. Higher yield serves as compensation for investors who choose more high-risk commercial paper.
For example, imagine that you have a choice between two three-month bills, both of which are output by two percent. The first bill offers a small biotech company and the other U.S. government t-bills. What is the law is a wise choice? In this case, any rational investor will probably choose the t-bills because the company serves biotech, because it is much more likely that the US government will pay its arrears compared to the much less stable, much less, face like a biotech firm. If, on the other hand, biotech bills give ten percent, the decision becomes more complex. In order to make the right decision, the investor must consider the likelihood that a small company can pay its debt, and the amount of risk he or she is ready to take over.
In General, when there are two accounts with the same maturity, the bill, which has lower credit quality or clients will offer a higher return to investors because there is a high probability that the lender will not be able to meet its debt obligations.
(To learn more, check out Bond basics Tutorial.)