“A good name is to be chosen rather than great riches, and favor is better than silver or gold.”
“Dishonest money dwindles away, but whoever gathers money little by little makes it grow.”
“If you lend money to any of my people who are in need, do not charge interest as a money lender would.”
Sources:
(2) Corporate Finance Institute – Commercial Paper
(3) Federal Reserve System – Commercial Paper Rates
(4) Wall Street Prep – Commercial Paper
(5) Corporate Finance Institute – Revolving Credit Facility
(6) FDIC PDF – Commercial Paper Backed By Credit Card Receivables
(7) Verses on Money – OpenBible
(8)
Commerical Paper 101
Commercial paper is “a short-term, unsecured debt obligation that is issued by financial institutions & large corporations as an alternative to costlier methods of funding.”
Commercial paper is issued at a discount & matures at par/face value, making it a zero-coupon debt security. Since commercial paper is zero-coupon, it trades without accrued interest (trades flat).
A zero-coupon debt security does not pay interest & trades at a discount.
Interest is payable at maturity; instead of being paid semi-annually like many other debt securities.
The maximum length of time required for maturity of commercial papers is no more than 270 days. If a company issues commercial paper with a maturity greater than 270 days, it will have to meet additional registration requirements with the SEC.
The Federal Reserve only considers commercial papers with maturity dates of 270 days or less; since these commercial papers qualify as exempt from SEC registration requirements. However, no security—SEC-exempt or not—avoids anti-fraud regulations.
Many maturity dates for commercial papers average about 30 days. Other common maturity dates: 60, 90, and 120 days.
Commercial paper is typically issued with a par/face value of $100,000 million dollars or more; though, $1 million dollars is common.
Commercial paper helps raise money for payroll, property, equipment, and other business reasons.
Commercial paper has less regulations & restrictions than many other securities. Typically, larger institutional investors with significant capital are suitable to invest in commercial paper securities.
Large financial institutions often buy commercial paper. These financial institutions will repackage the security into other financial vehicles like money market funds. This allows repackaged commercial paper to be accessible to a retail investor with less capital than a large institutional investor would typically have access too.
Buying Commercial Paper At A Discount
As mentioned above, commercial paper securities are often purchased by institutional investors at a discounted rate compared to their par/face value.
The investor should then receive the par/face value if they hold the security till maturity.
Example:
Company X needs to borrow $1 million dollars for the acquisition of real estate to build a distribution center in Idaho.
Company X issues a $1 million par/face value, 250-day commercial paper at a discounted price of 98% of the par/face value.
Institutional Investor Y buys the commercial paper security for $980,000 (98% of Par). Investor Y holds the commercial paper security till maturity, 250 days.
At maturity (250 days), Investor Y receives $1 million dollars from Company X.
The $20,000 difference between the discounted purchase price $980,000 & $100,000 price at maturity is counted as interest received for Investor Y.
However, it is worth noting that Investor Y does not need to hold the commercial paper to maturity. Company X will pay the face/par value at maturity to whoever holds the commercial paper security.
As with most debt securities, commercial paper can be traded to other investors at market price. The new investor will qualify to receive the maturity payment, instead of the previous one.
“A good name is rather to be chosen than great riches, and loving favour rather than silver and gold.”
“Wealth gained by dishonesty will be diminished, But he who gathers by labor will increase.”
“If you lend money to any of My people who are poor among you, you shall not be like a moneylender to him; you shall not charge him interest.”
Credit/Default Risks
Commercial paper securities are sold on trust. The credit risk of smaller companies may reduce the trust required to produce a market for commercial papers.
Investors need to trust the issuers will repay the commercial paper debt security.
As the average maturity date of a commercial paper is thirty days, liquidity is less of a risk for investors. The main risk is the credit/default risk.
Typically, only large corporations (blue-chip companies) with high credit ratings will be able to sell commercial papers at a reasonable rate.
Smaller corporations with less favorable credit ratings, may rely on other debt instruments—that require collateral—to raise capital.
Restrictions on Proceeds
A downside to the utilization of commercial paper to raise capital is “companies are restricted to using the proceeds on current assets, namely inventory and accounts payable. Specifically, the cash received as part of the commercial paper arrangement cannot be used to fund capital expenditures (Capex)-i.e., the purchase of long-term fixed assets (PP&E).”
An alternative debt vehicle to raise capital is the Revolving Credit Facility.
Asset Backed Commercial Paper (ABCP)
Asset Backed Commercial Paper (ABCP) is a variation of commercial paper backed by collateral. The collateral is in the form of “trade receivables, credit card receivables, or medium-term financial assets.” This pool of assets helps secure ABCP claims.
ABCP, like typical commercial paper, is still issued at a discount & matures at face/par value.
ABCPs are still short-term notes with an original maturity date of 270 days or less.
The ABCP has different restrictions and may allow the issuer to use the cash received for long-term spending needs (Capex).
Regulations on ABCP increased following the 2008 Global Financial Crisis (subprime mortgage crisis), as the issuance of ABCP was involved.
“Choose a good reputation over great riches; being held in high esteem is better than silver or gold.”
“Wealth obtained by fraud dwindles, But the one who gathers by labor increases it.”
“If you lend money to My people-to the poor person among you, you must not be like a moneylender to him; you must not charge him interest.”
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