Overview
Commercial paper (CP) is a money market security that represents an unsecured promissory note. It is typically issued by large corporations with strong credit ratings to finance short-term liabilities, such as accounts payable, inventories, and payroll.
Key Concepts
Key features of commercial paper include:
- Maturity: Typically ranges from overnight to 270 days. Longer maturities are rare to avoid SEC registration.
- Denomination: Issued in large denominations, often $100,000 or more.
- Issuance: Sold at a discount to its face value, with the difference representing the interest.
- Unsecured: Backed only by the issuer’s creditworthiness, not by collateral.
Deep Dive
The commercial paper market is a vital component of the short-term debt market, providing issuers with a flexible and often cheaper alternative to bank loans. Investors benefit from short-term liquidity and relatively low risk, especially when investing in paper from highly-rated companies.
Applications
Corporations use commercial paper primarily for:
- Working capital management: Financing day-to-day operations.
- Seasonal funding needs: Meeting temporary increases in demand for cash.
- Bridging finance: Covering short-term gaps before longer-term financing is secured.
Challenges & Misconceptions
A common misconception is that all commercial paper is risky. However, the market distinguishes between high-grade CP (issued by top-rated companies) and lower-grade CP. A significant challenge can be market liquidity during times of financial stress.
FAQs
What is the typical maturity for commercial paper?
Commercial paper typically matures within 270 days, often much shorter, like overnight or a few weeks.
Who typically issues commercial paper?
Large, creditworthy corporations with established reputations are the primary issuers of commercial paper.
Is commercial paper considered safe?
It is generally considered safe, especially when issued by highly-rated corporations, but it carries more risk than government-backed securities.