What is Commercial Paper?

417 reads · Last updated: December 5, 2024

Commercial paper is an unsecured, short-term debt instrument issued by corporations. It's typically used to finance short-term liabilities such as payroll, accounts payable, and inventories. Commercial paper is usually issued at a discount from face value. It reflects prevailing market interest rates.Commercial paper involves a specific amount of money that is to be repaid by a specific date. Minimum denominations are $100,000. Terms to maturity extend from one to 270 days. They average 30 days.

Definition

Commercial paper is an unsecured, short-term debt instrument issued by companies. It is typically used to finance short-term liabilities such as payroll, accounts payable, and inventories. Commercial paper is usually issued at a discount to face value, reflecting prevailing market interest rates. It involves a specific amount of money to be repaid by a certain date, with a minimum denomination of $100,000. Maturities range from one to 270 days, averaging 30 days.

Origin

The origin of commercial paper dates back to the early 19th century in the United States, when companies needed a flexible financing method to meet short-term funding needs. As financial markets evolved, commercial paper became an important financing tool, especially in the mid-20th century, as markets matured and regulations improved, leading to its widespread use.

Categories and Features

Commercial paper can be categorized into direct issuance and brokered issuance. Direct issuance is typically conducted by large corporations with sufficient market influence and creditworthiness. Brokered issuance is suitable for small to medium-sized enterprises, leveraging brokers' networks and expertise to reach investors. Key features of commercial paper include its unsecured nature, short-term maturity, and issuance at a discount, making it a flexible and cost-effective financing option.

Case Studies

Case Study 1: General Electric (GE) utilized the commercial paper market during the 2008 financial crisis to raise substantial short-term funds to maintain its daily operations and liquidity needs. Case Study 2: Apple Inc. used commercial paper in 2013 to manage its cash flow and short-term liabilities, demonstrating the application of commercial paper in large tech companies.

Common Issues

Common issues investors might face when dealing with commercial paper include the uncertainty of returns due to market interest rate fluctuations and the assessment of the issuing company's credit risk. Investors should carefully evaluate the financial health of the issuing company and the market environment to mitigate investment risks.

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