Commercial paper (CP) is a short-term, unsecured debt instrument issued by corporations, financial institutions, and other large entities to raise funds for their short-term financing needs. It is typically issued for periods ranging from 1 to 270 days and is usually sold at a discount to its face value.
CP is considered a highly liquid investment, as it can be easily bought and sold in the open market before its maturity. It is often used by corporations to finance their day-to-day operations, such as payroll, inventory, and accounts payable, as well as for other short-term financing needs.
CP is typically issued in denominations of $100,000 or more, making it a relatively high-value investment. It is primarily bought by institutional investors, such as money market funds, insurance companies, and pension funds, as well as by wealthy individuals.
CP is subject to credit risk, as it is unsecured and does not have any collateral to back it up. However, it is considered a relatively safe investment due to the short-term nature of the instrument and the high creditworthiness of the issuers, which are typically large, established corporations with strong credit ratings.
CP is regulated by the Securities and Exchange Board of India (SEBI) and can only be issued by entities that have been approved by SEBI. The minimum credit rating required for CP issuers is P-2, as rated by a designated credit rating agency.
Overall, commercial paper is a useful and important financial instrument for corporations and investors alike. Its short-term nature and high liquidity make it an attractive investment option for those looking for a low-risk, short-term investment opportunity.
There are two main types of commercial paper:
- Unsecured Commercial Paper: This type of commercial paper is not backed by any specific collateral or asset. The creditworthiness of the issuer and the strength of its balance sheet are the primary factors that determine the interest rate on unsecured commercial paper.
- Asset-backed Commercial Paper (ABCP): ABCP is backed by specific assets, such as accounts receivable, inventory, or loans. The assets act as collateral, making ABCP less risky than unsecured commercial paper. ABCP is typically issued by a special purpose vehicle (SPV) that pools together these assets and issues the commercial paper to investors.
Both types of commercial paper are typically issued at a discount to their face value, with the discount representing the interest rate paid to investors. Commercial paper is generally considered a safe, low-risk investment due to its short-term nature and the creditworthiness of the issuers.