A Commercial Paper is a money-market security issued (sold) by large corporations to obtain funds to meet short-term debt obligations (for example payroll), and is backed only by an issuing bank or company promise to pay the face amount on the maturity date specified on the note.
When you invest in a commercial paper, you purchase at a discount to receive the full value at maturity. For example, when you buy a commercial paper with a face value of N100,000 and an implied interest rate of 10% you actually pay the company N90,000. Upon maturity, the company redeems the commercial paper by paying you N100,000.
With commercial paper, the yield is usually higher than for any of the other money market instruments because its repayment lies on the ability of the issuing company to honour the repayment obligation. Thus, while companies borrow from banks at a rate of 20%, a commercial paper can attract a yield of 25%. The yield a company attracts for commercial papers also depends on the credit rating of the company.
Commercial Papers are usually issued for maturities between 15 days to 270 days maximum tenor, including rollover, from the date of issue.
Characteristics of Companies That Issue Commercial Paper:
- Favorable Credit rating.
- Strong brand and reputation.
- Experienced and stable management team.
Why Do Companies Issue Commercial Papers?
- Commercial Paper issuance can serve as a preamble to any future bond offering by the issuer. Balance sheet efficiency creates greater potential funding capacity for the issuer.
- Issuance of Commercial Paper helps a company complement its other sources of working capital, while diversifying its funding sources to include non-bank investors.
- It also enables companies acquire investments that are tradable without a penalty
What Investors stand to gain from Commercial Papers:
- Commercial Paper is a liquid instrument with strong secondary market trading possibilities making it an attractive product for potential investors.
- It can help to provide greater risk diversification for investors.
In Nigeria, some of the banks and companies have issued Commercial Papers include; Skye Bank, Nigerian Breweries, and Guinness Nigeria Plc.
See articles on companies that have issued commercial papers.