Commercial
paper
is a money-market security issued by large banks and corporations.
It is generally not used to finance long-term investments but
rather to purchase inventory or to manage working capital. It
is commonly bought by money funds (the issuing amounts are often
too high for individual investors), and is generally regarded
as a very safe investment. As a relatively low-risk investment,
commercial paper returns are not large. There are four basic kinds
of commercial paper: promissory notes, drafts, checks, and certificates
of deposit.
Because commercial
paper maturities do not exceed 270 days and proceeds typically
are used only for current transactions, the notes are exempt from
registration as securities with the United States Securities and
Exchange Commission.
Commercial
paper is defined in Canada as having a maturity of not more than
one year and is exempt from dealer registration and prospectus
requirements.[1]
Commercial
paper essentially can be compared as an alternative to lines of
credit with a bank. Once a business becomes large enough, and
maintains a high enough credit rating, then using commercial paper
is always cheaper than using a bank line of credit. Nevertheless,
many companies still maintain bank lines of credit to act as a
"backup" to the commercial paper. In this situation, banks often
charge fees for the amount of the line of the credit that does
not have a balance. While these fees may seem like pure profit
for banks, if the company ever actually needs to use the line
of credit it would likely be in serious trouble and have difficulty
repaying its liabilities.
Currently,
more than 1,700 companies in the United States issue commercial
paper. Financial companies comprise the largest group of commercial
paper issuers, accounting for nearly 75 percent of the commercial
paper outstanding at mid-year 1990. Financial-company paper is
issued by firms in commercial, savings and mortgage banking; sales,
personal and mortgage financing; factoring; finance leasing and
other business lending; insurance underwriting; and other investment
activities. The remaining commercial paper outstanding at mid-year
1990 -- over 25 percent -- was issued by nonfinancial firms such
as manufacturers, public utilities, industrial concerns and service
industries.
Commercial
paper was invented by Percy "Max" Hall, Vice President of Manufacturers
Hanover Trust Bank, in the 1920's.
Issuing
commercial paper
There are
two methods of issuing paper. The issuer can market the securities
directly to a buy and hold investor such as most money funds.
Alternatively, it can sell the paper to a dealer, who then sells
the paper in the market. The dealer market for commercial paper
involves large securities firms and subsidiaries of bank holding
companies. Most of these firms also are dealers in US Treasury
securities. Direct issuers of commercial paper usually are financial
companies that have frequent and sizable borrowing needs and find
it more economical to sell paper without the use of an intermediary.
In the United States, direct issuers save a dealer fee of approximately
5 basis points, or 0.05% annualized, which translates to $50,000
on every $100 million outstanding. This saving compensates for
the cost of maintaining a permanent sales staff to market the
paper. Dealer fees tend to be lower outside the United States.
Notes
and References
External
links
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