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Commercial Paper Why To Invest.

1002 words - 4 pages

Commercial Paper, otherwise known as CP, is an obligation issued by a corporation or a bank to finance its short term credit needs. It can be either unsecured or asset-backed. Maturities can range from 2 to 270 days. It is available in many denominations, can be either discounted or interest bearing, and usually has a small or nonexistent secondary market. It is issued by companies with high credit ratings and therefore considered to be a relatively low risk investment.Companies like GM or PepsiCo are multi billion dollar companies. They have many accounts with their vendors and suppliers. Sometimes they have short term needs for large amount of cash to pay certain accounts like receivables or inventory. Rather than taking a large loan from a bank they will issue promissory notes to investors or investment companies usually at a lower interest rate than what they could have obtained from a bank loan. This provides a win-win situation for both the company and the investor.Commercial paper is usually issued in very large denominations and isn't ordinarily purchased by the general public. Minimum denominations are usually $100,000, although face amounts as low as $10,000 are available from some issuers. Because most investors are institutions, typical face amounts are in multiples of 1 million. Issuers will usually sell an investor the specific amount of CP needed.Although CP is considered to be an investment vehicle, it is not required to be registered with the SEC. The SEC does not require anything investment with a maturity less than 9 months to be registered. Corporations took advantage of this loophole and this is the reason the maximum maturity on any CP is 270 days.A major factor in the lack of registration with the SEC is that registration for short term securities is especially expensive because the registration fee is a percent of the face amount of each offering. Thirty day notes, rolled over monthly for one year would cost 12 times as much as a one time issuance of an equal amount of one year notes. If companies registered CP with the SEC, even if they were to extend the maturity, the cost would decrease the profitability so much they would actually be better off to borrow the funds from a bank.The SEC however, does restrict what the funds can be used for. Because they are deemed short term, proceeds from CP issues must be used to finance current transactions which include the funding of operating expenses, and the funding of current assets such as receivables and inventories. Proceeds can not be used to finance fixed assets, such as plant and equipment, on a permanent basis.The general maturity length of CP is anywhere form 2-270 days. Some issuing companies prefer to have the maturity last the maximum time possible, while some companies may not need the funds that long, and do not want to pay interest on funds outstanding. The average maturity of commercial paper is estimated to be 30 days. Some issuances of commercial paper have the...

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