What Is a Paper Dealer?
A paper dealer is a market maker that stands ready to buy and sell extremely short-term corporate bonds called commercial paper or other money market instruments. A paper dealer is typically a large financial firm that has the capital and level of sophistication necessary to distribute commercial paper to investors on behalf of borrowing corporations and to make a two-sided market in commercial paper, setting prices at which it is willing to buy (bids) and sell (offers).
- A paper dealer is a market maker establishing two-sided markets in the commercial paper or money market.
- Paper dealers are most often large financial institutions such as investment banks or hedge funds.
- While some institutional buyers or issuers of commercial paper transact directly, many prefer to make use of the additional liquidity and wider net of a paper dealer.
Understanding Paper Dealers
A paper dealer essentially acts as a market maker who purchases commercial paper from an issuer and resells them to investors, but who can also serve as broker that directly matches buyers and sellers. An investor who purchased the original issue and wishes to sell can do so through the liquidity provided by the dealer, who stands ready to purchase the paper from the investor by establishing a bid price.
If the issuer needs to increase the amount of its outstanding paper, it may contact its paper dealer on the morning of the day the funds are required, given that no advance notification is required. The dealer takes a small markup on the paper they place to investors by charging a fee to the issuer based on the amount of commercial paper outstanding.
Commercial Paper and Dealers
Commercial paper is commonly traded type of unsecured debt security issued by firms looking to raise capital in the short term in order to fund day-to-day operations. These notes are typically issued at a discount to par with average maturity dates less than 270 days.
Purchasers of commercial paper are typically institutional investors who purchase these securities for inclusion in money market funds. Other major buyers of commercial paper are pension funds, insurance companies, state and local governments, as well as other corporations seeking to enhance yield on their cash holdings. These entities can purchase commercial paper either directly from the issuer or from a paper dealer.
Likewise, issuing companies that prefer not to administer their own commercial paper distribution programs, will seek out the services of a paper dealer.
Occasionally, individual or retail investors can buy commercial paper directly from the issuing corporation. However, it is more common for retail investors to invest in commercial paper through a money market fund, short-term bond fund, or exchange-traded fund (ETF).
Paper dealers are used by corporations that wish to access the public markets for their short-term borrowing needs. By issuing commercial paper, a corporation may be able to obtain a larger amount of financing and/or obtain a lower interest rate on its short-term borrowings, as compared to seeking a bank loan or other short-term credit facility. In addition, paper dealers offer financial advice to issuers, especially first-time issuers who require advice on how to deal with rating agencies and create investor interest.
Since paper dealers often act as principal, that is, they buy and sell commercial paper to make a profit by taking their own long or short positions, they are regulated by the Securities and Exchange Commission (SEC), which requires that all paper dealers trade securities as a registered business.