Commercial Paper

Commercial paper (CP) is essentially a short-term corporate bond. It is an unsecured promissory note with a fixed maturity of no more than 270 days. Commercial paper is a money-market security issued by large corporations to obtain relatively large funds to meet short-term debt obligations (for example, payroll).

CP issue allows you to use cash initially designated for meeting this obligation to finance an attractive investment project when an opportunity presents itself. Thus, this issue becomes a way to raise indirect external financing for this project.  

Since it is not backed by any collateral, only companies with excellent credit ratings from a recognized credit rating agency will be able to sell their commercial paper at a reasonable price. Commercial paper is usually sold at a discount from face value, and carries higher interest repayment rates than regular corporate bonds.

Typically, the longer the maturity on a CP, the higher the interest rate the issuing institution pays. Interest rates fluctuate with market conditions, but are typically lower than banks' rates. Which is exactly what makes CP an attractive alternative to a bank loan (in addition to it being unsecured). Also, CP investors (holders of commercial paper) typically have less power in relationships with an issuer than banks – with the debtor.

Commercial paper – though a short-term obligation – is usually issued as part of a continuous rolling program, which expires after a fixed number of years, or is open-ended.

You should analyze any commercial paper issue as an investment project aimed at creating financial value. This project must make financial sense (i.e. generate positive cash flows); economic sense (i.e. generate positive economic profit) and yield acceptable values of NPV and IRR. The key question that you must keep in mind when performing CP analysis is “How are we going to make money with this issue?”