What Is Commercial Paper?

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What Is Commercial Paper?

Let me tell you directly: commercial paper is an unsecured, short-term debt instrument that corporations issue when they need to raise capital for immediate needs. You see it used to cover things like payroll, accounts payable, and inventories. It involves a fixed amount of money repaid by a set date, with minimum denominations starting at $100,000. The terms run from one to 270 days, averaging around 30 days.

Understanding Commercial Paper

Commercial paper dates back to colonial times as bills of exchange. By the 1920s, New York merchants sold their short-term obligations to dealers to cover near-term needs. These dealers bought the paper—promissory notes—at a discount from par value and sold it to banks and investors. The merchants repaid the par value. It's unsecured, so no collateral backs it, leading to higher yields compared to secured options. This differs from asset-backed commercial paper, which has issuer-selected assets behind it. Only firms with high credit ratings issue it, finding buyers easily without deep discounts. It's issued in $100,000+ denominations, bought by corporations, financial institutions, and wealthy individuals.

Fast Fact

Here's a quick note: Marcus Goldman, founder of Goldman Sachs, was the first money market dealer to buy commercial paper. His firm became a top dealer post-Civil War.

Types of Commercial Paper

Companies issue various forms based on their needs. Let me break down the main types for you.

Promissory Notes

These are written promises to pay a set amount on a specific date. Companies use them to borrow without collateral, with terms from days to a year. Sold at a discount, they redeem at face value, so the difference is your interest.

Drafts

Drafts are orders from one party directing another—often a bank—to pay a third party. In trade financing, they help buy goods and services. They can be sight drafts, payable on demand, or time drafts, due later.

Bankers' Acceptances

These are time drafts guaranteed by a bank, common in international trade for exporter security. The bank promises to pay at maturity, and they trade in secondary markets before due.

Certificates of Deposit (CDs)

CDs are bank-issued time deposits with fixed interest for a set period. They're low-risk, backed by the bank, though insured amounts may cap. Large, short-term CDs fit into commercial paper due to liquidity.

Repurchase Agreements (Repos)

Repos involve selling securities with a promise to repurchase at a set price later. Secured by the securities, they're short-term loans in money markets.

Commercial Paper Terms

The issuer is the entity raising funds—usually large, credit-strong corporations. Maturity is up to 270 days, often 30. It's unsecured, no collateral, so bankruptcy risks loss. Issued at discount to face value, typically $100,000 denominations. It ties to liquidity: issuers boost short-term cash, buyers hold for future needs.

Advantages and Disadvantages of Commercial Paper

It doesn't require SEC registration if under 270 days, making it a cheap, simple financing option versus loans. Issuers get lower rates with low default risk, and investors diversify. But issuers need top credit, proceeds only for current assets, not fixed ones without SEC. Returns are low, and $100,000 minimum excludes small investors directly.

Who Issues Commercial Paper?

Large corporations with strong ratings issue it, no collateral needed. They span industries like manufacturing for inventory or services for payroll, expecting quick revenue to repay.

Who Buys Commercial Paper?

Main buyers are institutional investors like money market funds for liquidity and returns. Corporate treasurers use it for cash management, as do pension funds and banks for asset-liability matching.

Commercial Paper vs. Bonds

Both are debt, but commercial paper matures in 1-270 days, bonds in 1-30 years. No coupons for commercial paper—one payment at maturity—while bonds pay interest periodically. Bonds often require collateral, unlike unsecured commercial paper.

Example of Commercial Paper

Say a retailer needs $10 million for holiday inventory. It issues $10.1 million face value paper. At maturity, investors get $10.1 million, yielding 1% interest, adjusted for term like 30 days.

Is Commercial Paper a Type of Debt?

Yes, it's short-term unsecured debt for quick capital, cheaper than loans.

Who Are the Primary Buyers of Commercial Paper?

Large institutions like investment companies, retirement accounts, governments, and firms.

How Do Individuals Invest in Commercial Paper?

With $100,000 minimum, invest via money market funds, mutual funds, or ETFs that buy it.

What Are The Maturity Periods for Commercial Paper?

From 1 to 270 days, commonly 30, 60, or 90 days, reducing default risk.

What Are The Risks Associated With Commercial Paper?

Mainly credit risk—issuer default, as it's unsecured, relying on their stability.

The Bottom Line

Commercial paper is short-term unsecured debt from high-rated companies, cheaper than loans for short needs. It offers low rates for issuers and better returns than some bonds for investors, aiding portfolio diversification.

What Is Commercial Paper?

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