DEFINITION of 'Short-Term Paper'

Short-term papers are financial instruments that typically have original maturities of less than nine months. Short-term paper is typically issued at a discount and provides a low-risk investment alternative.

BREAKING DOWN 'Short-Term Paper'

Short-term papers are negotiable debt instruments that are either unsecured or backed by assets such as loans issued by a corporation. Structured investment vehicles (SIV) that invest in long-term assets finance those assets by selling short-term paper with an average maturity of 90 days. The paper is backed by a pool of mortgages or loans used by collateral and is, hence, referred to as short-term asset-backed paper. In the case of default, investors of the asset-backed paper can seize and sell the underlying collateral assets.

Examples of short-term paper include U.S. Treasury bills and negotiable instruments issued by financial and non-financial corporations, such as commercial papers, promissory notes, bills of exchange, and certificates of deposit (CDs). In the case of U.S. Treasury bills, the papers are backed by the full faith and credit of the U.S. government and are, thus, considered the safest investments because the government cannot default.

Mutual funds invest deeply in short-term paper due to their relatively safe and high liquidity features. These financial instruments are part of the money market and are issued at a discount to par and repaid the face value upon maturity. The difference between the purchase price and the face value of the security represents the return on investment for the holders. For the issuer, this difference represents the cost of financing the loan security. The debt security can also be issued as an interest-bearing security.

The papers are usually issued with a minimum denomination of $25,000. This means the major investors of these securities are institutional investors who seek short-term vehicles to deposit their cash temporarily given that short-term papers are an alternative to holding cash in a bank account. It is not uncommon for issuers to adjust the amounts and/or the maturities of papers to suit the investment needs of a particular buyer or group of buyers. Investors can purchase short-term paper directly from the issuer or through dealers who act as intermediaries between the issuer and lender.

The majority of financial institutions rely on being able to roll over short-term paper for their day-to-day financing needs. During the U.S. financial-market meltdown of 2008, institutions essentially halted issuing short-term paper, and the U.S. government had to intervene to provide liquidity for corporations caught without the means to finance operations.

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