Commercial paper is a company’s short-term promise to repay
Commercial paper lets companies fund near-term needs with short-dated notes, but repayment and liquidity risks remain.
By Marcus V. Thorne · Markets Editor
· 4 min read
Commercial paper is a short-term promissory note, or a company’s promise to repay an investor on a stated date. Companies issue it to raise cash for current needs. In traditional commercial paper, repayment rests on the issuer’s ability to pay because the note is unsecured and no specific collateral is pledged.
In the United States, the Federal Reserve’s commercial-paper coverage extends to notes maturing in 270 days or less, and maturities average about 30 days. Commercial paper can be sold directly to investors by an issuer or placed through a dealer.
What is commercial paper used for?
Businesses use commercial paper for working capital, receivables financing and other short-term financing needs. The Federal Reserve says many companies use it to raise cash for current transactions and find it a lower-cost alternative to bank loans.
How commercial paper works
- The company issues a note. It sets a face value, or amount due at maturity, and a maturity date.
- An investor supplies cash. Commercial paper is often sold at a discount to face value. Federal Reserve market data describe primary-market transactions as sales by dealers or direct issuers to investors.
- The company repays at maturity. If the issuer performs its obligation, the investor receives the amount due under the note.
A simplified example
A company sells a 30-day note with a face value of $100,000 for $99,000. The investor pays $99,000 at issue and, if the note is repaid as promised, receives $100,000 at maturity. The $1,000 difference is the return for that 30-day holding period. This illustration excludes transaction costs and does not state an annualised interest rate.
Traditional commercial paper and ABCP
- Traditional commercial paper: An unsecured corporate promissory note. The key credit question is whether the issuer can repay.
- Asset-backed commercial paper, or ABCP: Paper supported by specified assets and their cash flows, such as credit-card receivables or auto loans. It is usually issued through a conduit, or special-purpose vehicle, established to facilitate the financing.
For ABCP, the underlying assets, any credit support and the issuer’s legal structure are relevant to the assessment of the paper. For traditional commercial paper, the issuer’s financial strength remains central.
Why credit quality and liquidity matter
Because traditional commercial paper is unsecured, investors face default risk if the issuer cannot pay. Credit ratings and reviews can inform an assessment, while the support and legal structure of an issue can also matter.
A secondary market exists for investors seeking to sell before maturity, but issuer-specific problems or wider market disruption can impair that market. The Government Finance Officers Association says commercial paper is generally less liquid than U.S. Treasury and government-agency obligations. During disruptions, an issuer may also be unable to sell new paper to refinance notes as they mature; GFOA says commercial paper is usually backed by bank lines of credit to mitigate that risk.
The U.S. 270-day rule
Commercial paper with a maturity not exceeding 270 days is exempt from Securities and Exchange Commission registration, according to the Federal Reserve. This is a U.S. registration treatment tied to that maturity threshold.
How to read commercial-paper market data
The Federal Reserve publishes commercial-paper rates, issuance volumes, amounts outstanding and maturity distributions using data supplied by the Depository Trust & Clearing Corporation. Its published rate indexes are estimates built from eligible trades and weighted by face value, so an index measures activity in a defined market segment and may not equal the rate on a particular company’s note.
Frequently asked questions
What does the 270-day limit mean for commercial paper?
In the United States, commercial paper with a maturity not exceeding 270 days is exempt from SEC registration. The Federal Reserve’s commercial-paper data also cover maturities of 270 days or less.
What is asset-backed commercial paper?
Asset-backed commercial paper, or ABCP, is supported by specified assets and their cash flows, such as credit-card receivables or auto loans. It is usually issued through a conduit or special-purpose vehicle established to facilitate the financing.
Why can commercial paper become difficult to refinance?
During an issuer-specific event or a broader market disruption, an issuer may be unable to sell new commercial paper as older notes mature. The secondary market can also be impaired, limiting an investor’s ability to sell before maturity.
Sources
- About - The Fed - Commercial Paper Rates and Outstanding Summary — www.federalreserve.gov
- Using Commercial Paper in Investment Portfolios — www.gfoa.org
- Commercial Paper Overview: Key Advantages and Usages — www.investopedia.com
