DEFINITION of 'Tax-Exempt Commercial Paper'

Tax-exempt commercial paper is an unsecured short-term loan, usually issued to finance short-term liabilities, that provides the debt holders (bondholders) some level of tax preference on the earnings from their debt investment at a local, state or federal level, or a combination thereof. Tax-exempt commercial paper is issued with a fixed interest rate and must mature in less than 270 days. Commercial paper is typically issued in increments of $1,000.

BREAKING DOWN 'Tax-Exempt Commercial Paper'

Commercial paper is essentially a promissory note backed by the financial intuition's health. No federal government policy covers losses incurred from commercial paper. The Federal Deposit Insurance Company (FDIC) does not insure against losses from investing in tax-exempt commercial paper. An investor can ensure the commercial paper's safety by checking the ratings listed by rating agencies such as Standard & Poor's or Moody's. Because of default risk and timeliness issues, interest rates on commercial paper are typically higher than other short-term cash instruments. Tax-exempt commercial paper interest rates increase as the economy grows.

Impact of Taxation

Tax-exempt commercial paper is beneficial for issuers; the interest rate on tax-exempt debt is lower than taxable debt. Likewise, tax-exempt paper is potentially beneficial for purchaser, as the effective interest rate may be higher than taxable commercial paper.

Tax-exempt commercial paper issued by the government results in government support of certain entities or institutions. Instead of the government directly funding the institution, the government forgoes taxes that would have otherwise been collected on the interest income. Thus, tax-exempt commercial paper is an instrument of public policy as lost tax income is replaced with support of an institution.

Buyers and Sellers

Only companies with an investment-grade rating may issue commercial paper. Corporations and governments typically issue tax-exempt commercial paper, while banks, mutual funds, or brokerage firms buy tax-exempt commercial paper. These institutions may hold the commercial paper as an investment or act as an intermediary and resell the investment to their customers. There is a limited market for tax-exempt paper issued directly to smaller investors.

Due to the financial recession, starting in 2008, legislation restrictions were enacted to limit the type and amount of commercial paper that could be held in money market funds.

Tax-Free Commercial Paper Rates

The Federal Reserve Board (FRB) publishes current borrowing rates on commercial paper on its website. The FRB also publishes the rates of highly rated commercial paper in a statistical release occurring each Monday. Information relating to the total amount of outstanding paper issued is also released once per week.

RELATED TERMS
  1. Commercial Paper

    An unsecured, short-term debt instrument issued by a corporation, ...
  2. Commercial Paper Funding Program ...

    A program instituted in October of 2008 that created the Commercial ...
  3. Tax-Exempt Interest

    Interest income that is not subject to federal income tax. Tax-exempt ...
  4. Government Paper

    Debt securities that are issued or guaranteed by a sovereign ...
  5. White Paper

    An informational document issued by a company to promote or highlight ...
  6. Order Paper

    1. An order paper is a negotiable instrument that is payable ...
Related Articles
  1. Investing

    Introduction To Commercial Paper

    Commercial paper is a short-term instrument that can be a viable alternative for retail fixed-income investors looking for a better rate of return on their money.
  2. 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 ...
  3. Trading

    Pros And Cons Of Paper Trading

    Most market novices should paper trade for a considerable amount of time, despite key drawbacks.
  4. Financial Advisor

    3 Money Market Funds Worth Considering (VMSXX,PTEXX,FMOXX)

    Explore analyses of three tax-exempt money market funds that may be suitable for high net worth investors, and learn about the characteristics of these funds.
  5. Investing

    The Reality of Commercial Real Estate Loans

    It’s corporations and partnerships that most commonly take out commercial real estate loans.
  6. Taxes

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

    Prepare for global mayhem.
  7. Investing

    PIMCO Report: The Case for High Yield Bonds in 2016

    Discover how PIMCO's 2015 white paper strays from the company's mission to identify investment opportunities and risks for its clients.
  8. Investing

    Introduction To Money Market Mutual Funds

    Learn about the easiest way to benefit from money market securities.
  9. Investing

    The Money Market

    The money market provides a relatively stable place to park capital that may be needed within a short time horizon.
RELATED FAQS
  1. How can retail investors invest in commercial paper?

    Find out how individual retail investors can purchase short-term commercial paper, but why it rarely makes good investment ... 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. What are some examples of money market funds?

    Learn more about different types of money market mutual funds, including those that invest in government paper versus commercial ... Read Answer >>
  4. Which financial instruments have par values?

    Understand the difference between short-term investments and marketable equity securities, and learn the importance of short-term ... Read Answer >>
Hot Definitions
  1. Maintenance Margin

    The minimum amount of equity that must be maintained in a margin account. In the context of the NYSE and FINRA, after an ...
  2. Salvage Value

    The estimated value that an asset will realize upon its sale at the end of its useful life. The value is used in accounting ...
  3. Cryptocurrency

    A digital or virtual currency that uses cryptography for security. A cryptocurrency is difficult to counterfeit because of ...
  4. Promissory Note

    A financial instrument that contains a written promise by one party to pay another party a definite sum of money either on ...
  5. SEC Form 13F

    A filing with the Securities and Exchange Commission (SEC), also known as the Information Required of Institutional Investment ...
  6. Fixed Asset

    A long-term tangible piece of property that a firm owns and uses in the production of its income and is not expected to be ...
Trading Center