Commercial paper is an unsecured promissory note with a fixed maturity of one to 270 days. It is usually sold at a discount from face value. It is a money-market security issued by large banks and corporations backed only by their promise to pay the face amount on the date specified on the note. Since it is not backed by collateral, only firms with excellent credit ratings will be able to sell their commercial paper at a reasonable price.

In the money market, commercial paper is a financial instrument that matures before nine months (270 days), and is only used to fund operating expenses or current assets (e.g., inventories and receivables) and not used for fixed assets, such as a land, buildings, or machinery.^[1] By meeting these qualifications it may be issued without U.S. federal government regulation, that is, it need not be registered with the U.S. Securities and Exchange Commission.^[2] Commercial paper is a type of negotiable instrument, where the legal rights and obligations of involved parties are governed by Articles Three and Four of the Uniform Commercial Code, a set of non-federal business laws adopted by each of the 50 U.S. States.

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.^[3]

Commercial paper is an alternative to a line 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. At the end of 2007 there was $1.788 trillion in total outstanding commercial paper. Of which $839 billion was "asset backed" and $846 billion was not ($153 billion of this was issued by non-financial corporations, and $797 billion was issued by financial corporations).^[4]

History

Commercial paper, in the form of promissory notes issued by corporations, have existed since at least the 19th century. For instance, Marcus Goldman, founder of Goldman Sachs, got his start trading commercial paper in New York in 1869. ^[5]

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.

Defaults

Defaults on high quality commercial paper are rare, and cause concern when they occur.^[6] Notable examples include:

• June 1970: Penn Central, $82 million

• This led to Fed intervention.^[6]

• January 31, 1997: Mercury Finance (a major automotive lender), $17 million, rising to $315 million

• Effects were small, partly because default occurred during a robust economy.^[6]

• September 15, 2008: Lehman Brothers

• This caused two money funds to break the buck, and led to Fed intervention in money market funds.

See also

• Asset Backed Commercial Paper
• Financial instrument
• Negotiable instrument

Notes and References

External links

• Federal Reserve System release on commercial papers
• Commercial paper - Encyclopedic entry
• An article from The Times on commercial paper and credit market vernacular
• CP Daily - Premium provider of research and searchable databases relating to global CP and ECP markets.
• Stepek, John. What's wrong with commercial paper?MoneyWeek, August 31, 2007 - How the subprime crisis has affected the commercial paper market
• What is Commercial Paper? - Mortgage News Daily
• Fed Bank of Richmond, VA - History of origin, and special regulations governing issue of commercial paper. Thomas K Hahn, Federal Reserve Bank of Richmond
• The Week America's Economy Almost Died National Public Radio broadcast September 26, 2008.

de:Geldmarktpapier fr:Billet de trésorerie ko:???? id:Surat berharga komersial it:Commercial paper nl:Commercial paper pl:Commercial papers sk:Cenný papier