Commercial Papers, also known as CPs, are short-term fixed income instruments that firms issue to obtain capital for a period of up to one year. These unsecured loans provide the company with the working cash it requires on a short-term basis. They are frequently provided as promissory notes. In 1990, these products were first presented to the nation’s money market. Prior to the introduction of CPs, businesses had to provide collateral security for bank short-term loans. The majority of CP issuers in India are leasing and finance corporations, manufacturing businesses, and financial institutions.
Benefits of Commercial Papers :
Benefits to Issuers –
- Fill short-term working capital gaps: CPs offer businesses a cost-effective way to finance their short-term borrowing needs for durations ranging from seven days to a year. Commercial papers, as opposed to bank loans, can provide companies with additional funding at lower interest rates.
- Flexible: The maturity and coupon rate of the CP can be changed to meet the needs of the issuing corporation. As a result, CPs are more adaptable than other borrowing choices like loans.
- Tax-friendly: Interest on CPs is regarded as a company expense. Thus, it aids in lowering the company’s tax obligation.
Benefits to Investors –
- Diversification: If you have money stashed in conventional debt instruments, you may invest in CPs to create a diversified short-term portfolio that will enable you to achieve your short-term objectives.
- Less risky than longer-term papers: Because CPs are short-term financial instruments, they are less susceptible to changes in interest rates than longer-term financial instruments like bonds.
- CPs are governed by the Reserve Bank of India (RBI). Therefore, when issuing commercial papers, the issuer must adhere to the laws and regulations of the RBI.
- Investment flexibility across several maturities: Because a commercial paper’s maturity can range from seven days to a year, investors have the choice to invest in CPs that mature at various times.
How do Commercial Papers Work?
Companies can obtain seven-day to one-year short-term loans through CPs. The business that issues the CP decides on an interest rate or coupon rate based on the need and credit standing of the business. During the debut of the offering, investors can buy the securities in the primary market directly from the issuer or through distribution networks, including websites like Yubi. Before the instrument’s term expires, investors can also purchase CPs on the secondary market through websites like Yubi.
The creditworthiness of the underlying issuer influences the CP’s interest rate. So, by issuing commercial papers, a company with a good credit rating can raise money at a cheaper interest rate than a company with a bad credit rating.
Companies can issue two different types of CPs. In the first, there is no interest or coupon. The other, more common variant is when the face value of the paper is discounted, with the investor receiving the discount in the form of interest. Here is an illustration of the discounted CP in use. A CP with a face value of Rs 1,000 and a one-year maturity might be sold by issuers at a discount rate of Rs 918, giving the investor a 9% yield when the CP matures.
Investments in CPs are typically made by individuals, businesses, non-resident Indians (NRIs), banks, and foreign portfolio investors (FPIs).