Commercial Paper
important activity indicator in the corporate sector is the issuance of unsecured short-term commercial paper, with which financial and non-financial companies traditionally fund their day-to-day operations
Companies use commercial paper, or debt maturing in nine months or less, as a form of IOU to pay for day-to-day activities such as payrolls and rent.
Commercial paper is a money market security issued by large banks and corporations. It is generally not used to finance long-term investments but rather to purchase inventory or to manage working capital. It is commonly bought by money funds (the issuing amounts are often too high for individual investors), and is generally regarded as a very safe investment. As a relatively low risk option, commercial paper returns are not large. There are four basic kinds of commercial paper: promissory notes, drafts, checks, and certificates of deposit.
Because commercial paper maturities do not exceed nine months and proceeds typically are used only for current transactions, the notes are exempt from registration as securities with the United States Securities and Exchange Commission.
Commercial paper essentially can be compared as an alternative to lines of credit with a bank. Once a business becomes large enough, and maintains a high enough credit rating, then using commercial paper is always cheaper than using a bank line of credit.
Currently, more than 1,700 companies in the United States issue commercial paper. Financial companies comprise the largest group of commercial paper issuers, accounting for nearly 75 percent of the commercial paper outstanding at mid-year 1990.
Issuing
There are two methods of issuing paper. The issuer can market the securities directly to a buy and hold investor such as most money funds. Alternatively, it can sell the paper to a dealer, who then sells the paper in the market. The dealer market for commercial paper involves large securities firms and subsidiaries of bank holding companies. Most of these firms also are dealers in US Treasury securities. Direct issuers of commercial paper usually are financial companies that have frequent and sizable borrowing needs and find it more economical to sell paper without the use of an intermediary. In the United States, direct issuers save a dealer fee of approximately 5 basis points, or 0.05% annualized, which translates to $50,000 on every $100 million outstanding. This saving compensates for the cost of maintaining a permanent sales staff to market the paper. Dealer fees tend to be lower outside the United States.
August 2009: RGE Monitor reports "Asset-backed commercial paper--the short-term financing vehicle for SIVs and off-balance sheet conduits (before the run on those vehicles)--is still in free fall and points to ongoing difficulties in getting the over US$2 trillion securitization market going again on a sustainable basis (see Financial Innovation and Securitizations Come Back To Life: Business As Usual?)"
During the crisis: issue = (FDIC insured commmercial paper? )
Problem: constriction in commercial paper had become severe: the total volume on issue had fallen by 12 per cent, or about $200bn, in the past three weeks alone (to 10/7/08
10/2008:in an effort to solve the credit crisis: "Federal Reserve to buy up short-term commercial debt
About $1.3 trillion in commercial paper will be eligible for purchase, senior officials say. The hope is to encourage financial firms to start lending again."
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