Commercial papers are short-term debt financing securities consisting of unsecured and discounted promissory notes issued by large corporations with good credit ratings, which can be readily traded. They don’t go longer than 270 days in tenor. Due to their relatively short maturity period, commercial papers are referred to as low-risk investments, offering competitive returns to investors in compensation for the issuer’s credit risk.
Commercial papers are not usually backed by any form of collateral making it an unsecured debt. Consequently, only firms with high-quality debt ratings will easily find buyers without having to offer a substantial discount (higher cost) for the debt issue. Other corporations, financial institutions, wealthy individuals, and money market funds are usually buyers of commercial paper.
In Nigeria, investment in commercial papers is regulated by the Securities and Exchange Commission.
FEATURES OF COMMERCIAL PAPERS
- A Commercial paper is a negotiable instrument; which means it is flexible and also a liquid instrument.
- It is an unsecured instrument as it is not backed by any assets of the company.
- It can be sold by the issuing company, directly to the investors.
ADVANTAGES OF COMMERCIAL PAPERS
- One benefit of commercial papers is that, it is a cost effective way of financing working capital.
- The cost of commercial papers to the issuing firm is lower than the cost of securing a commercial bank loans.
- As commercial papers are required to be rated, good rating reduces the cost of capital for the company.
- Commercial papers produce a continual source of funds. This is because their maturity can be tailored to suit the needs of issuing firm. Again, commercial paper that matures can be repaid by selling the new commercial paper.
DISADVANTAGES OF COMMERCIAL PAPERS
- By issuing commercial papers, the credit available from banks may get reduced.
- Only financially secure and highly rated organizations can raise money through commercial papers. New and moderately rated organizations are not in a position to raise funds by this method.
- If a firm is not in a position to redeem its paper due to financial difficulties, extending the duration of commercial paper is not possible.