Commercial Paper
Candlefocus EditorCommercial paper is the most widely-traded form of unsecured debt securities in the U.S. market. It is typically issued by larger companies with good credit ratings, and the interest rate is based on market conditions. This rate can be considerably lower than interest payable on corporate bonds, which tend to offer higher return due to the added risk.
When investing in commercial paper, investors rely on the creditworthiness of the issuing company.Companies that are highly rated in the capital markets typically offer the lowest interest rates, while companies with lower credit ratings must pay higher interest. Companies that do not have access to the capital markets, or do not have a strong credit rating, are generally not eligible to issue commercial paper.
The process of issuing commercial paper involves the company obtaining a line of credit from a major financial institution. This line can vary from several million dollars to billions of dollars in size. The company then pledges a portion of the line as collateral against the principal of the commercial paper. This collateral is typically in the form of a letter of credit or a bank guarantee.
The company then sells the commercial paper at a fixed price to the investor, who stands to gain from the difference between the face value of the paper and the discounted price at which it was issued. The investor can redeem the paper on or before its maturity date for the face value and gain the expected return.
Commercial paper is one of the most important sources of finance for many companies, allowing them to manage their short-term cash needs in an efficient and cost-effective manner. The use of this instrument enables companies to maintain adequate working capital without having to resort to expensive long-term financing options such as issuing bonds. It also allows them to diversify their funding sources, reducing their reliance on loans from banks. For investors, commercial paper offers an attractive option to diversify their portfolios and take advantage of the potential returns.