Commercial paper

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Commercial paper consists of high-denomination, short-term unsecured debt instruments issued by corporations and traded directly on the money market without involving the SEC. Companies sell these promissory notes to raise money for their daily operations, to meet payroll, and other short term financial needs. It's a low-cost source of cash that is cheaper than tapping a line of credit from a bank. [1] [2]

The market began to grow in the 1970s as money-market mutual funds emerged and became large buyers of commercial paper. Since 1980, annual issuance of commercial paper has gone from $124 billion to $1.6 trillion.

Although these instruments are generally considered safe and low-yielding, the recent global credit crisis has significantly pushed up the price of cash for some commercial-paper issuers.

Easier money?

Commercial paper must mature within 270 days but averages around 30 days, and is usually offered at a discount to prevailing interest rates. The U.S. Federal Reserve publishes one-month, two-month and three-month rates on AA financial and AA non-financial commercial-paper rates in weekly statistical releases.[3] Because commercial paper is usually not issued in denominations below $100,000, retail investors typically gain exposure indirectly though money-market funds or money-market deposit accounts.[4]

Latest news

The 2007-2008 credit crisis has even hit the commercial-paper market, long considered as good as cash for security and affordability. Volume on the market has declined in recent months while issuing corporations have been forced to pay much higher interest rates of up to six percent on short-term paper.[5] This trend is likely to force more businesses back to banks for credit-line financing of short-term obligations like accounts receivable and payrolls at a time of bank contractions.

On October 7, 2008, the Federal Reserve said it would step in and purchase three-month unsecured and asset-backed commercial paper directly from issuers. Traditionally, when the Fed lends to banks and other financial institutions, the loans are secured by collateral, but in this case, the Fed plans to collect up-front fees paid by issuers. The Treasury will make a special deposit at the Federal Reserve Bank of New York to support this facility. It is the first time the Fed has intervened in the commercial-paper market since the Depression.[6] The Fed released a statement that said, in part: "The commercial paper market has been under considerable strain in recent weeks as money market mutual funds and other investors, themselves often facing liquidity pressures, have become increasingly reluctant to purchase commercial paper, especially at longer-dated maturities."


References

  1. The Trust Crunch by James Surowiecki. The New Yorker.
  2. What is commercial paper?. International Herald Tribune.
  3. About Commercial Paper. U.S. Federal Reserve.
  4. Money Market: Commercial Paper. Investopedia - Forbes Digital.
  5. Banks Are Squeezed, Credit Is Crushed. Forbes.
  6. "Not Yet the Last Resort". The Economist.