Commercial paper

Definition

Commercial paper is a short-term, unsecured promissory note issued by corporations to raise funds for working capital needs, typically with maturities ranging from a few days to up to 270 days. It serves as a crucial financing tool for businesses, allowing them to manage liquidity without resorting to more expensive forms of credit like bank loans. As corporate capitalism and finance evolved, commercial paper became a significant instrument in capital markets, providing an efficient way for companies to obtain short-term financing.

5 Must Know Facts For Your Next Test

1. Commercial paper is typically issued at a discount to face value, which allows investors to earn interest when the note matures.
2. The primary issuers of commercial paper are large corporations with strong credit ratings, as the notes are not backed by any collateral.
3. This form of financing is generally cheaper than bank loans because it allows companies to bypass traditional banking fees and interest rates.
4. Commercial paper plays a vital role in the money market, influencing short-term interest rates and liquidity in the financial system.
5. The commercial paper market can be sensitive to economic conditions; during financial crises, its usage may decline due to increased risk aversion among investors.

Review Questions

• How does commercial paper function as a financial tool for corporations in managing their working capital?
  • Commercial paper allows corporations to quickly access short-term funds necessary for managing their working capital needs. By issuing these unsecured promissory notes, companies can finance everyday operations, such as payroll and inventory purchases, without incurring the higher costs associated with bank loans. This flexibility enables firms to maintain liquidity and operational efficiency in a fast-paced business environment.
• Evaluate the impact of the commercial paper market on the overall corporate finance landscape during periods of economic instability.
  • During economic instability, the commercial paper market can significantly impact corporate finance by influencing liquidity and access to short-term funding. When investors become risk-averse, they may pull back from purchasing commercial paper, leading companies to struggle in securing necessary funds. This situation can force firms to rely more heavily on bank loans or other financing methods, which could strain their finances further and exacerbate economic challenges.
• Synthesize the role of commercial paper within the broader context of corporate capitalism and finance in the modern economy.
  • Commercial paper plays an integral role in modern corporate capitalism by facilitating efficient access to short-term financing for large corporations. This mechanism supports businesses in maintaining liquidity and operational agility, thereby enabling them to respond quickly to market changes. As corporate finance has evolved, the prominence of commercial paper reflects broader trends towards financial innovation and the increasing importance of capital markets in driving economic growth and stability.

Related terms

corporate bonds: Debt securities issued by corporations to raise long-term capital, with fixed interest payments and defined maturity dates.

money market: A sector of the financial market in which financial instruments with high liquidity and short maturities are traded.

line of credit: A flexible loan from a bank or financial institution that allows the borrower to draw funds up to a predetermined limit as needed.