What It Is:
Commercial paper is an unsecured and discounted promissory note issued to finance the short-term credit needs of large institutional buyers. Banks, corporations and foreign governments commonly use this type of funding.
How It Works/Example:
Exempt from SEC registration, commercial paper generally matures in a short period of time and usually does not exist for more than 270 days. The average maturity of commercial paper is between 30 and 35 days. The average investment is about $100,000, but some commercial paper investments are made in multiples of $1 million or more. It is not uncommon for issuers to adjust the amounts and/or the maturities of commercial paper to suit the investment needs of a particular buyer or group of buyers.
Commercial paper is usually issued by companies with very high credit ratings. Because of this, and because it generally matures in a very short period of time, commercial paper tends to be a very low-risk investment. Most commercial paper is assessed by more than one rating agency. The four primary agencies are: Moody's, Standard & Poor's, Fitch, and Duff & Phelps.
Although commercial paper is occasionally issued as an interest-bearing note, it typically trades at a discount to its par value. In other words, investors usually purchase commercial paper below par and then receive its face value at maturity. The discount, or the difference between the purchase price and the face value of the note, is the interest received on the investment. All commercial paper interest rates are quoted on a discounted basis.
Why It Matters:
Commercial paper is issued by a wide variety of domestic and foreign firms, including financial companies, banks, and industrial firms.
Major investors in commercial paper include money market mutual funds and commercial bank trust departments. These large institutional investors often prefer the cost savings inherent in using commercial paper instead of traditional bank loans.