Commercial Paper

Lesson

Commercial paper is a short-term, unsecured debt instrument corporations issue to finance their short-term cash needs. It is a popular investment vehicle in the money market due to its low risk and high liquidity. Investors in commercial paper include institutional investors, money market funds, and individual investors.

Practice Question #1

Which of the following best describes commercial paper?

A) A long-term, secured debt instrument

B) A short-term, unsecured debt instrument

C) A long-term, unsecured debt instrument

D) A short-term, secured debt instrument

Select an option above to see an explanation here.

A) Commercial paper is short-term, not long-term, and unsecured, not secured. B) Commercial paper is a short-term, unsecured debt instrument issued by corporations. C) Commercial paper is short-term, not long-term. D) Commercial paper is unsecured, not secured.

Terms

Commercial paper:: A short-term, unsecured debt instrument corporations issue to finance their short-term cash needs.
Maturity:: The time until the debt instrument is due to be repaid, typically from overnight to 270 days for commercial paper.
Discount:: The difference between the face value of the commercial paper and the purchase price, which represents the interest earned by the investor.
Face value:: The amount the issuer agrees to pay the investor at maturity.
Money market:: A financial market where short-term debt instruments are traded.
Money market funds:: Mutual funds that invest in short-term debt instruments, such as commercial paper, to provide investors with a high degree of liquidity and safety.

Practice Question #2

Which of the following is a key difference between commercial paper and Treasury bills?

A) Maturity

B) Issuer

C) Liquidity

D) Interest rate

Select an option above to see an explanation here.

A) Both commercial paper and Treasury bills have short-term maturities. B) Corporations issue commercial paper, while Treasury bills are issued by the U.S. government. C) Both commercial paper and Treasury bills are highly liquid investments. D) Both commercial paper and Treasury bills pay interest through a discount from face value.

Do Not Confuse With

Treasury bills:: Short-term debt instruments issued by the U.S. government are considered even safer than commercial paper due to the issuer's creditworthiness.
Certificates of deposit (CDs):: Time deposits issued by banks that pay a fixed interest rate and have a specified maturity date, typically ranging from a few months to several years.
Repurchase agreements (repos):: Short-term loans in which one party sells a security to another party with an agreement to repurchase it at a specified price on a specified date, usually within a few days.
Bankers' acceptances:: Short-term debt instruments issued by a company and guaranteed by a bank, used primarily in international trade transactions.

Practice Question #3

What type of investor is most likely to invest in commercial paper?

A) Individual investors

B) Institutional investors

C) Government entities

D) Non-profit organizations

Select an option above to see an explanation here.

A) Individual investors may invest in commercial paper, but they are not the most likely type of investor. B) Institutional investors, such as pension funds and insurance companies, are the most likely to invest in commercial paper. C) Government entities typically do not invest in commercial paper. D) Non-profit organizations may invest in commercial paper, but they are not the most likely type of investor.

Historical Example

In the late 2000s, the commercial paper market experienced a significant decline due to the global financial crisis. Many investors became concerned about the creditworthiness of issuers and the risk of default, leading to a decrease in demand for commercial paper. This caused borrowing costs for corporations to rise, making it more difficult for them to obtain short-term financing.

Practice Question #4

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Example Series 65 Example Practice Question

Real-World Example

A large corporation needs to raise funds to cover its payroll expenses for the next month. So it issues commercial paper with a face value of $10 million and a maturity of 30 days. Investors purchase the commercial paper at a discount, giving the corporation the cash it needs to meet its short-term obligations. At maturity, the corporation repays the investors the full face value of the commercial paper.