Commercial paper is a type of short-term debt instrument issued by corporations, banks, and other financial institutions to raise funds for working capital, inventory financing, or other short-term liquidity needs. The maturity of commercial paper typically ranges from one day to 270 days, with most issuances having a maturity of 30 to 60 days.
Commercial paper is usually sold at a discount to its face value, with the difference between the face value and the discounted price representing the interest paid to the investor. Because commercial paper is unsecured, investors rely on the issuer’s creditworthiness to determine the risk associated with the investment.
The primary buyers of commercial paper are money market mutual funds, which provide a low-risk, low-return investment option for investors seeking short-term liquidity. Other buyers include corporations with excess cash reserves and institutional investors like pension funds and insurance companies.
Commercial paper can be issued on an ongoing basis, with the issuer rolling over maturing paper by issuing new commercial paper to repay the old debt. This allows issuers to maintain ongoing access to short-term funding.
In the United States, commercial paper issuers are regulated by the Securities and Exchange Commission (SEC) and are required to meet certain creditworthiness standards and disclosure requirements. The credit rating agencies also play a key role in determining the creditworthiness of commercial paper issuers, with higher-rated issuers typically able to issue paper at lower interest rates than lower-rated issuers.
Overall, commercial paper is an important component of the short-term debt market, providing issuers with access to low-cost financing and investors with a relatively safe and liquid investment option.
There are several types of commercial paper, including:
- Asset-backed commercial paper (ABCP): This type of commercial paper is backed by a pool of assets, such as auto loans, credit card receivables, or mortgages.
- Unsecured commercial paper: This type of commercial paper is not backed by collateral and relies on the issuer’s creditworthiness to determine the level of risk.
- Bank-issued commercial paper: Commercial paper issued by banks is backed by the issuing bank’s creditworthiness and is typically considered less risky than commercial paper issued by corporations or other financial institutions.
- Euro-commercial paper (ECP): This is commercial paper issued by corporations or financial institutions in currencies other than their domestic currency.
- Tax-exempt commercial paper: This type of commercial paper is issued by state and local governments, and is exempt from federal income tax.
- Dematerialized commercial paper: This is a type of commercial paper that is issued and traded electronically, rather than in physical form.