Commercial Paper
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Commercial paper is an unsecured promissory note, which is issued by banks and large financial institutions to arrange money to meet their short terms needs. Commercial paper is issued for a fixed maturity period of 1 to 270 days and is not backed by any collateral.[br]
Commercial paper is an unsecured promissory note, which is issued by banks and large financial institutions to arrange money to meet their short terms needs. Commercial paper is issued for a fixed maturity period of 1 to 270 days and is not backed by any collateral.[br]
To issue commercial papers, a financial institution must have an excellent credit rating to command decent prices. Commercial papers are generally priced at rates lower than the face value and have shorter repayment models than bonds or other similar bank issued securities.
Bigger banks with higher credit ranking are able to command higher prices than others and their prices may not be much lower than the face value. However, irrespective of the financial institution they come from, commercial papers should be invested in after much thought and deliberation.
Is Commercial Paper A Good Investment?
Most investors are attracted to money market financing due to their higher returns. Bonds and other securities are willingly sought after. However commercial papers are a different story all together.
Firstly, being unsecured, a commercial paper carries a significantly higher risk than other money market securities. The higher and quicker repayments assuage the risk a little; however, don’t rule out the high risk that an investor potentially ‘buys’.[br]
Secondly, most banks and financial institutions issue commercial papers to raise capital for investments. Banks and financial institutions issue these securities with an expectation that investors won’t pull out. However, there have been cases when the banks have been found wanting. German Bank (IKB) was caught in a financial mess once the investors pulled out from its $19 bn conduit. In fact, IKB is not the only example. HSBC and Barclays have faced such crunch as well. HSBC has an excess of $40bn in conduits whereas Lloyds TSB has more than $25 bn.
It is for this reason that investors should exercise a lot of caution while investing in money market. Always look to strike the right balance between safety, liquidity, yield and convenience. Though chasing yield in the money market may help you in making quick money, in effect, it only compensates you for the risk that you willingly take up.
