Commercial Paper

Commercial paper is an unsecured, short-term debt instrument issued by corporations to finance immediate needs such as payroll, accounts payable, and inventory. It is typically issued in large denominations (commonly $100,000 or more), sold at a discount, and repaid at face value at maturity. Maturities range from one day up to 270 days, with the average issue around 30 days.

Key takeaways

• Unsecured, short-term corporate debt used for working capital.
• Issued at a discount and repaid at face value; no periodic coupon payments.
• Typical maturities: 1 to 270 days (most common: 30, 60, 90 days).
• Minimum denomination is usually large, so primary buyers are institutions.
• Issuers generally require strong credit ratings.

Brief history

Commercial paper evolved from colonial-era bills of exchange. In the late 19th and early 20th centuries, money-market dealers began buying merchants’ short-term obligations and selling them to investors, creating a liquid market for these promissory notes.

Main types

• Promissory notes: Unsecured written promises to pay a fixed amount on a set date; sold at a discount and redeemed at par.
• Drafts: Orders to pay a specified sum, often used in trade finance; can be payable on demand (sight) or at a future date (time).
• Bankers’ acceptances: Time drafts guaranteed by a bank, commonly used in international trade and tradable in secondary markets.
• Large-denomination certificates of deposit (CDs): Bank time deposits included in the broad money-market category; unlike most commercial paper, they are bank-backed.
• Repurchase agreements (repos): Secured short-term loans where securities are sold and later repurchased at a set price.

Key characteristics and terms

• Issuer: Typically large, creditworthy corporations or financial institutions.
• Maturity: From 1 to 270 days; issues longer than 270 days generally fall under SEC registration rules.
• Security: Most commercial paper is unsecured; asset-backed commercial paper (ABCP) is backed by underlying assets.
• Pricing: Issued at a discount — the investor’s return equals the difference between the purchase price and face value.
• Liquidity: Highly liquid for high-rated issuers and attractive to cash managers seeking short-term placements.

Advantages

• Cost-effective and quicker to arrange than bank loans.
• No SEC registration required for maturities ≤ 270 days.
• Lower interest costs for well-rated issuers.
• Useful tool for short-term cash management and liquidity matching.

Disadvantages and risks

• Issuer credit risk: Unsecured status means investors rely on issuer creditworthiness; default risk exists.
• Requires strong issuer credit rating—small or weak firms typically cannot access this market.
• Limited use of proceeds: Generally for current assets and short-term needs, not long-term capital projects.
• Low yields compared with longer-term securities; minimum investment amounts exclude many retail investors.

Who issues and who buys it?

Issuers:
* Large corporations across industries (manufacturers, service firms, retailers).
* Financial institutions and occasionally government-sponsored entities.

Buyers:
* Money market funds
* Corporate treasuries managing excess cash
* Banks and other financial institutions
* Pension funds and insurance companies

Small investors usually gain exposure indirectly through money market funds or mutual funds that include commercial paper.

Commercial paper vs. bonds

• Maturity: Commercial paper (days to 270 days); bonds (years).
• Payments: Commercial paper pays no periodic coupons and is redeemed at par; bonds typically pay periodic interest.
• Security: Commercial paper is usually unsecured; bonds may be secured or unsecured depending on the issue.
• Use: Commercial paper finances short-term working capital; bonds fund longer-term investments.

Example

A retailer needs $10 million for seasonal inventory. It issues commercial paper with a face value of $10.1 million maturing in 30 days. Investors pay $10 million today and receive $10.1 million at maturity. The effective interest for the 30-day period is $100,000 (1% annualized depending on convention).

Common questions

Q: Is commercial paper debt?
A: Yes — it is short-term, unsecured corporate debt.

Q: Who are the primary buyers?
A: Institutional cash managers—money market funds, banks, pension funds, insurers, and corporate treasuries.

Q: How can individuals invest?
A: Indirectly via money market funds, mutual funds, or ETFs that hold commercial paper.

Q: What are the main risks?
A: Credit/default risk of the issuer and limited diversification if holdings are concentrated.

Bottom line

Commercial paper is an efficient, low-cost way for creditworthy firms to meet short-term financing needs and for institutional investors to park cash with modest returns and short maturities. Its attractiveness depends on issuer credit quality and investors’ liquidity and risk preferences.