Commercial paper in finance terms

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commercial paper

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Namespaces Article Talk. Views Read Edit View history. By using this site, you agree to the Terms of Use and Privacy Policy. Forwards Options Spot market Swaps. The advantages of commercial paper from the standpoint of buyers are fourfold. The paper is rated prime. In addition to the buyer's own credit check, commercial paper dealers and brokers maintain extensive credit files and the paper that they place is subjected to credit examination.

Such middlemen could not long continue in business if commercial paper issuers from whom they purchase could not meet their maturities. Commercial paper dealers and brokers, therefore, in recent decades have raised the standards of their paper through use of audited financial statements, credit investigation, and even influence over the borrowing and operating policies of borrowers, so that losses on commercial paper have been negligible even in years of depression.

Commercial paper purchases, therefore, are arranged only with concerns that have a firmly established earning power, open lines of credit to cover outstandings, adequate balances and financial condition, and other satisfactory banking relationships. Confidence gradually returned, however, as evaluation and rating procedures were tightened.

As of , a virtual boom in commercial paper outstandings had developed.

There is no moral obligation to renew commercial paper, i. This differs from loans made to a bank's customers, where renewals might be necessary either as protection to the bank or as favour to a temporarily embarrassed borrower. Commercial paper furnishes a good investment medium, either for diversification of the "note pouch" of an investing bank to avoid overlarge proportion of local loans or for paper when the demand for credit over-the-counter has slackened. Commercial paper is attractive on a yield basis, in view of its quality, maturity, and liquidity.

The alleged disadvantage of commercial paper for the buyer is that usually it is single-name paper which does not evidence on its face the purpose for which the proceeds are used.

Use commercial paper in a sentence

This disadvantage, however, is more apparent than real in view of the credit tests applied to the issuer. Commercial paper is usually purchased on an option running from 10 to 20 days. Within this period, the prospective purchaser retains the right to return any notes that he or she finds to be undesirable, the purpose of the option period being to give the buyer the opportunity to check the credit responsibility of the issuer. Instead of commercial banks and corporations, as has been the case in past years, chief classes of investors in commercial paper are such nonblank investors as money market funds and other mutual funds, savings banks, insurance companies, private pension funds, and state and municipal retirement funds.

Non-financial company commercial paper is issued to meet the needs of public utilities and firms in manufacEagle Tradersg, construction, mining, wholesale and retail trade, and transportation and service industries.

What is a Commercial Paper ?

The Money Market. Dow Jones-Irwin, Inc. The information on this site is for information purposes only and do not convey or imply advice, a request, offer or solicitation of any kind.

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Generally, only corporations with the highest credit rating can issue commercial paper. Some companies with weaker credit can get credit enhancements , so that they can issue commercial paper. Asset-backed commercial paper is backed by high quality collateral. Credit-supported commercial paper is often guaranteed by an organization with excellent credit, such as a bank. Often, a letter of credit is used for this purpose, which is referred to as LOC paper.

commercial paper

The bank promises to pay the face value of the paper if the issuer doesn't. Other costs that the issuer must pay are agents' fees to a bank for doing the paperwork necessary to issue commercial paper, and thousands of dollars must be spent to have the issue rated by a credit rating organization , such as Standard and Poor's and Moody's. Most commercial paper has a maturity of about 45 days, and most are less than 90 days, although some commercial paper has a maturity of up to days. The terms of the commercial paper is determined by a number of factors. One factor is the market.

Buyers of commercial paper generally buy the terms that they want to coincide with their need for money. The day limit is dictated by the need to register the security with the SEC if the maturity is longer.

Commercial paper: more risk, less return |

This greatly increases the expense and time to issue—hence, commercial paper will rarely have terms longer than this. If the issuer needs the money longer, it can usually rollover the issue by issuing new commercial paper to pay off the maturing paper, which is often done. However, when credit dries up, then the issuer may become financially stressed.

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One of the aggravating factors of the - credit crisis was the inability to roll over maturing debt. There is also a day barrier for the length of terms. When a bank borrows from the Federal Reserve Bank discount window , it must provide collateral.

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