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Commercial Paper         

(Source: Thomas K. Hahn)

Characteristics of Commercial Paper
Market participants 
Risk in the Commercial Paper Market 
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    Ratings  (Member section)
    Backup Liquidity
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    Credit Enhancements
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    Default History and Yields
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    Foreign Commercial Paper Markets
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    The Growing Importance of Commercial Paper 
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Commercial paper is a short-term unsecured promissory note issued by corporations and foreign governments for many large, creditworthy issuers.  Commercial paper is a low-cost alternative to bank loans. Issuers are able to efficiently raise large amounts of funds quickly and without expensive Securities and Exchange Commission (SEC) registration by selling paper, either directly or through independent dealers, to a large and varied pool of institutional buyers.  Competitive, market-determined yields in notes whose maturity and amounts can be tailored to specific needs, can be earned by investors in commercial paper.

Commercial paper has become one of America's most important debt markets, because of the advantages of commercial paper for both investors and issuers.  Commercial paper outstanding grew at an annual rate of 14 percent from 1970 to 1991.  Commercial paper totaled $528 billion at the end of 1991.

This chapter describes some of the important features of the commercial paper market. The first section reviews the characteristics of commercial paper. The second section describes the major participants in the market, including the issuers, investors, and dealers. The third section discusses the risks faced by investors in the commercial paper market along with the mechanisms that are used to control these risks. The fourth section discusses some recent innovations, including asset-backed commercial paper, the use of swaps in commercial paper financing strategies, and the international commercial paper markets.

Characteristics of Commercial Paper 
Securities offered to the public must be registered with the Securities and Exchange Commission according to the Securities Act of 1933.  Registration requires extensive public disclosure, including issuing a prospectus on the offering.  It is a time-consuming and expensive process. Most commercial paper is issued under Section 3(a)(3) of the 1933 Act which exempts from registration requirements short-term securities as long as they have certain characteristics.

The exemption requirements have been a factor shaping the characteristics of the commercial paper market.  The following are requirements for exemption:
- The maturity of commercial paper must be less than 270 days. In practice, most commercial paper has a maturity of between 5 and 45 days, with 30-35 days being the average maturity. Many issuers continuously roll over their commercial paper, financing a more-or-less constant amount of their assets using commercial paper.  The nine-month maturity limit is not violated by the continuous rollover of notes, as long as the rollover is not automatic but is at the discretion of the issuer and the dealer. Many issuers will adjust the maturity of commercial paper to suit the requirements of an investor

Notes must be of a type not ordinarily purchased by the general public. In practice, the denomination of commercial paper is large: minimum denominations are usually $100,000, although face amounts as low as $10,000 are available from some issuers.  Typical face amounts are in multiples of $1 million, because most investors are institutions.  Issuers will usually sell an investor the specific amount of commercial paper needed.

That proceeds from commercial paper issues 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 cannot be used to finance fixed assets, such as plant and equipment, on a permanent basis. The SEC has generally interpreted the current transaction requirement broadly, approving a variety of short-term uses for commercial paper proceeds as proceeds are not traced directly from issue to use.  Firms are required to show only that they have a sufficient "current transaction" capacity to justify the size of the commercial paper program (for example, a particular level of receivables or inventory). Firms are allowed to finance construction as long as the commercial paper financing is temporary and to be paid off shortly after completion of construction with long-term funding through a bond issue, bank loan, or internally generated cash flow.

Commercial paper is typically a discount security (like Treasury bills): the investor purchases notes at less than face value and receives the face value at maturity. The difference between the purchase price and the face value, called the discount, is the interest received on the investment. Commercial paper is, occasionally, issued as an interest-bearing note (by request of investors). The investor pays the face value and, at maturity, receives the face value and accrued interest. All commercial paper interest rates are quoted on a discount basis.

Until the 1980s, most commercial paper was issued in physical form in which the obligation of the issuer to pay the face amount at maturity is recorded by printed certificates that are issued to the investor in exchange for funds. A safekeeping agent hired by the investor held the certificates, until presented for payment at maturity. The "settling" of the transaction, (the exchange of funds for commercial paper first at issuance and then at redemption, occur in one day. On the day the commercial paper is issued and sold, the investor receives and pays for the notes and the issuer receives the proceeds. On the day of maturity, the investor presents the notes and receives payment. Commercial banks, in their role as issuing, paying, and clearing agents, facilitate the settling of commercial paper by carrying out the exchanges between issuer, investor, and dealer required to transfer commercial paper for funds.

An increasing amount of commercial paper is being issued in book-entry form whereby entries in computerized accounts are replacing the physical commercial paper certificates. Book-entry systems will eventually completely replace the physical printing and delivery of notes. The Depository Trust Company (DTC), a clearing cooperative operated by member banks, began plans in September 1990 to convert most commercial paper transactions to book-entry form. By May 1992, more than 40 percent of commercial paper was issued through the DTC in book-entry form.

The advantages of a paperless system are significant.  In the long run the fees and costs associated with the book-entry system will, be significantly less than under the physical delivery system. The expense of delivering and verifying certificates and the risks of messengers failing to deliver certificates on time will be eliminated.  As all transactions between an issuing agent and a paying agent will be settled with a single end-of-day wire transaction, the problem of daylight overdrafts, which arise from non-synchronous issuing and redeeming of commercial paper will be reduced.

Market participants 
Issuers and Uses
of Commercial Paper  Commercial paper is issued by a wide variety of domestic and foreign firms, including financial companies, banks, and industrial firms. Finance companies are the biggest issuers in the financial firm category.  Finance companies provide consumers with home loans, unsecured personal loans and retail automobile loans. They provide businesses with a variety of short- and medium-term loans including secured loans to finance purchases of equipment for resale. Some finance companies are wholly owned subsidiaries of industrial firms that provide financing for purchases of the parent firm's products. For example, a major activity of General Motors Acceptance Corporation (GMAC) is the financing of purchases and leases of General Motor's vehicles by dealers and consumers.

The three largest issuers--GMAC, General Electric Capital, and Ford Motor Credit--accounted for more than 20 percent of the total non-bank financial paper outstanding at the end of 1991.

The financial issuer category also includes securities firms and insurance firms.  Securities firms issue commercial paper as a low-cost alternative to other short-term borrowings such as repurchase agreements and bank loans, and they use commercial paper proceeds to finance a variety of security broker and investment banking activities.  Insurance companies issue commercial paper to finance premium receivables and operating expenses. 

Commercial bank holding companies issue commercial paper to finance operating expenses and various non-bank activities. Due to declines in the perceived creditworthiness of many major domestic bank issuers, bank holding companies have recently decreased their commercial paper issues.

More than 500 non-financial firms also issue commercial paper. Non-financial issuers include public utilities, service and industrial companies. Commercial paper is used by Industrial and service companies to finance working capital (accounts receivable and inventory) on a permanent or seasonal basis, to fund operating expenses, and to finance, on a temporary basis, construction projects. Public utilities also use commercial paper to fund nuclear fuels and construction. 

The domestic commercial paper issuers ......... 


Slovin, Myron B., Marie E. Sushka, and Carl D. Hudson. "Corporate Commercial Paper, Note Issuance Facilities, and Shareholder Wealth," Journal of International Money and Finance, vol. 7 (1988), pp. 289-302.

Standard & Poor's Corporation. Commercial Paper Ratings Guide. April 1991.

Stigum, Marcia. The Money Market. Homewood, Ill.: Dow Jones-Irwin, 1990.

Wakeman, L. Macdonald. "The Real Function of Bond Rating Agencies," Chase Financial Quarterly, vol. 1 (Fall 1981), pp. 19-25. 

Wall, Larry D., and John J. Pringle. "Interest Rate Swaps: A Review of the Issues," Federal Reserve Bank of Atlanta Economic Review,  November/December 1988, pp. 22-40.

The information in this chapter was last updated in 1993. Since the money market evolves very rapidly, recent developments may have superseded some of the content of this chapter.

More information is provided in the Member Area

Recommended further reading:
Type of Instruments
Corporate Debt Securities 
Commercial Paper Outstandings Federal Reserve 
Bankers Acceptances 
Books on Financial Instruments

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