Loading the player...

What is 'Commercial Paper'

Commercial paper is an unsecured, short-term debt instrument issued by a corporation, typically for the financing of accounts receivable, inventories and meeting short-term liabilities. Maturities on commercial paper rarely range any longer than 270 days. Commercial paper is usually issued at a discount from face value and reflects prevailing market interest rates.

BREAKING DOWN 'Commercial Paper'

Commercial paper is not usually backed by any form of collateral, making it a form of unsecured debt. As a result, only firms with high-quality debt ratings will easily find buyers without having to offer a substantial discount (higher cost) for the debt issue. Because commercial paper is issued by large institutions, the denominations of the commercial paper offerings are substantial, usually $100,000 or more. Other corporations, financial institutions, wealthy individuals and money market funds are usually buyers of commercial paper.

Advantages of Commercial Paper

A major benefit of commercial paper is that it does not need to be registered with the Securities and Exchange Commission (SEC) as long as it matures before nine months, or 270 days, making it a very cost-effective means of financing. Although maturities can go as long as 270 days before coming under the purview of the SEC, maturities for commercial paper average about 30 days, rarely reaching that threshold. The proceeds from this type of financing can only be used on current assets, or inventories, and are not allowed to be used on fixed assets, such as a new plant, without SEC involvement.

Commercial Paper During the Financial Crisis

The commercial paper market played a big role in the Financial Crisis starting in 2007. As investors began to doubt the financial health and liquidity of firms such as Lehman Brothers, the commercial paper market froze and firms were no longer able to access easy and affordable funding. Another effect of the commercial paper market freezing was some money market funds, substantial investors in commercial paper, "breaking the buck." This meant that the affected funds had net asset values under $1, reflecting the diminishing value of their outstanding commercial paper issued by firms of suspect financial health.

Example of Commercial Paper

An example of commercial paper is when a retail firm is looking for short-term funding to finance some new inventory for an upcoming holiday season. The firm needs $10 million and it offers investors $10.1 million in face value of commercial paper in exchange for $10 million in cash, according to prevailing interest rates. In effect, there would be a $0.1 million interest payment upon maturity of the commercial paper in exchange for the $10 million in cash, equating to an interest rate of 1%. This interest rate can be adjusted for time, contingent on the number of days the commercial paper is outstanding.

Want to know more? Read Introduction To Commercial Paper.

RELATED TERMS
  1. Paper Dealer

    A market maker that buys and sells extremely short-term corporate ...
  2. Fine Paper

    High-quality securities that are assumed to be risk free, or ...
  3. Short-Term Paper

    Financial instruments typically with original maturities of less ...
  4. Paper Money

    The physical notes or currency of a country that is used as a ...
  5. Paper Trade

    Using simulated trading to practice buying and selling securities ...
  6. Government Paper

    Debt securities that are issued or guaranteed by a sovereign ...
Related Articles
  1. Investing

    Commercial Paper

    Commercial paper is a short-term debt security issued by financial companies and large corporations. The corporation promises the buyer a return, or profit, for making the loan. The return is ...
  2. Financial Advisor

    Money Market Mayhem: The Reserve Fund Meltdown

    This event serves as a stark reminder to investors about understanding their portfolios.
  3. Trading

    How to Practice Day Trading

    Day traders face intense competition in today's market, which makes practice more important than ever for achieving above-market risk-adjusted returns.
  4. Tech

    Is the ICO Whitepaper Dead?

    As more and more cryptocurrencies enter the market, the template of the white paper-the document touting the benefits of a new product-has changed.
  5. Investing

    Five Paper Companies Licensed To Print Money

    Here's a sector that significantly outperformed the broader market year to date.
  6. Insights

    The Role of Commercial Banks in the Economy

    We interact with commercial banks daily to carry out simple financial tasks. That said, the function and creation of a commercial bank is anything but simple.
  7. Investing

    The Money Market

    The money market provides a relatively stable place to park capital that may be needed within a short time horizon.
  8. Investing

    The Commercial Property Boom Is Fading

    Investors are selling off commercial real estate assets in a sign that this boom market may be ending.
  9. Taxes

    Panama Papers: Searchable Database of All 214,000 Parties Now Live

    Prepare for global mayhem.
RELATED FAQS
  1. What happens when a company defaults on its commercial paper obligations?

    Read about the possible consequences of a large corporation defaulting on its commercial paper obligations even though the ... Read Answer >>
  2. What are some examples of securities that can be found in a money market fund?

    Learn about examples of securities found in money market accounts. These securities need to be safe, liquid and of short-term ... Read Answer >>
  3. How does investment banking differ from commercial banking?

    Discover how investment banking differs from commercial banking, the responsibilities of each and how the two can be combined ... Read Answer >>
  4. How do investment banks help the economy?

    Learn more about the functions of investment banks in a modern economy and how investment banks have been treated differently ... Read Answer >>
Hot Definitions
  1. Nostro Account

    A bank account held in a foreign country by a domestic bank, denominated in the currency of that country. Nostro accounts ...
  2. Retirement Planning

    Retirement planning is the process of determining retirement income goals and the actions and decisions necessary to achieve ...
  3. Drawdown

    The peak-to-trough decline during a specific record period of an investment, fund or commodity. A drawdown is usually quoted ...
  4. Inverse Transaction

    A transaction that can cancel out a forward contract that has the same value date.
  5. Redemption

    The return of an investor's principal in a fixed income security, such as a preferred stock or bond; or the sale of units ...
  6. Solvency

    The ability of a company to meet its long-term financial obligations. Solvency is essential to staying in business, but a ...
Trading Center