what is commercial paper 
commercial paper is an unsecured short term debt instrument issued by corporations it s typically used to finance short term liabilities such as payroll accounts payable and inventories commercial paper involves a specific amount of money that is to be repaid by a specific date minimum denominations are 100 000 terms to maturity extend from one to 270 days they average 30 days investopedia madelyn goodnightunderstanding commercial papercommercial paper was first introduced during colonial times and was referred to as a bill of exchange they became more modern during the 1920s when new york merchants began to sell their short term obligations to dealers to access capital needed to cover near term obligations these dealers or middlemen purchased the paper also known as promissory notes at a discount from their par value they then sold the paper to banks and other investors the merchants would repay the investors an amount equal to the par value of the note 1commercial paper is not backed by any form of collateral making it an unsecured debt and will usually have a higher yield 2 it differs from asset backed commercial paper abcp a class of debt instrument backed by assets selected by the issuer in either case commercial paper is only issued by firms with high ratings from credit rating agencies 3 these firms can easily find buyers without having to offer a substantial discount at a higher cost to themselves for the debt issue commercial paper is issued by large institutions in denominations of 100 000 or more 2 other corporations financial institutions and wealthy individuals are usually buyers of commercial paper marcus goldman the founder of investment bank goldman sachs was the first dealer in the money market to purchase commercial paper his company became one of the biggest commercial paper dealers in america following the civil war 4types of commercial paperthere are a bunch of different types of commercial paper as companies can issue different forms of items depending on the criteria they re willing to commit to here are the main types of commercial paper promissory notes are written promises to pay a specific amount of money on a certain date they are used by companies to borrow funds without having to use any collateral and promissory notes can range from just a few days to up to a year promissory notes are sold at a discount from their face value and redeemed at face value upon maturity meaning the difference between those two amounts is technically the interest earned drafts are orders written by one party the drawer directing another party the drawee to pay a specified sum to a third party the payee the drawee is usually a bank as commercial paper drafts can be used in trade financing to facilitate the purchase of goods and services drafts can be either sight drafts which are payable on demand or time drafts which can be payable at a specific future date bankers acceptances are time drafts that have been accepted and guaranteed by a bank they are commonly used in international trade to ensure payment to exporters the bank s acceptance of the draft means that the bank promises to pay the face value of the draft at maturity which gives certain parties a level of security bankers acceptances can also be traded in the secondary market before maturity cds are time deposits issued by banks that pay a fixed interest rate for a specified period cds are considered low risk investments since they are backed by the issuing bank however there may be a dollar cap as to the amount that is insured while they are technically not unsecured like most commercial paper large denominations of cds are often included in the broader category of commercial paper because of their relative level of liquidity and short term nature assuming a more brief cd length repos are agreements in which one party sells securities to another with a promise to repurchase them at a specified price on a future date although repos are secured by the underlying securities they are frequently used as a form of short term borrowing in the money markets because a repo transaction includes the initial sale and the repurchase agreement it acts as a short term loan commercial paper termsthe issuer of commercial paper is the entity that is creating the short term debt to fund their short term cash needs as mentioned earlier most issuers are large corporations with strong credit as the issuer may demonstrate a high probability of being able to pay back debt especially in the short term the maturity of commercial paper designates how long the debt is outstanding for the issuer commercial paper often a term up to 270 days though companies often issue commercial paper with a maturity of 30 days 2 at the end of the maturity period the commercial paper is technically due and the issuer is now liable to return investor capital though they may choose to simply re issue more commercial paper commercial paper is often unsecured which means there is no collateral for the debt the issuing company is taking on if the issuing company goes bankrupt holders of the issuer s commercial paper may not have recourse in receiving funds the idea is because commercial paper s maturity is so short and the credit worthiness of issuers is higher the debt does not need backing by corporate assets commercial paper is issued at face value meaning a debt instrument has a value to it often in denominations of 100 000 2 instead of paying interest commercial paper is instead often issued at a discount or a price that less than face value when the commercial paper reaches maturity the investor will receive the face value amount of the instrument even though they paid a lower discount amount 5commercial paper is often tied to liquidity the measurement of well a company s short term cash flows will be able to cover its short term debt therefore issuers often create commercial paper to increase their liquidity as it may need cash in the short term on the other hand buyers of commercial paper may not need cash right away so they are willing to buy and hold the instrument to increase their cash on hand in the future commercial paper is just like bonds though each instrument has its own unique characteristics advantages and disadvantages of commercial papera 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 in no more than nine months or 270 days 6this makes it a cost effective and simple 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 7commercial paper is also easier to deal with compared to the effort time and money involved in getting a business loan it offers issuers the advantage of lower interest rates while it offers investors a low risk of default commercial paper provides an effective way for investors to diversify portfolios companies must have extremely good credit to issue commercial paper 3 so it doesn t offer access to capital for all institutions 