Commercial Paper

Definition

Commercial paper is a short-term, unsecured debt instrument issued by corporations and other entities to raise funds for their immediate operational needs. It is a flexible and cost-effective way for companies to manage their cash flow and meet their short-term financial obligations.

5 Must Know Facts For Your Next Test

1. Commercial paper is typically issued in denominations of $100,000 or more and has maturities ranging from 1 to 270 days.
2. Companies with high credit ratings and strong financial positions are more likely to issue commercial paper, as it is seen as a low-risk investment.
3. Commercial paper is considered a liquid asset and is often used by companies to manage their short-term cash flow needs, such as payroll, inventory purchases, and other operational expenses.
4. The interest rate on commercial paper is generally lower than the interest rate on other short-term debt instruments, such as bank loans, making it an attractive financing option for companies.
5. The Federal Reserve closely monitors the commercial paper market as it is an important indicator of the overall health of the financial system and the economy.

Review Questions

• Explain how commercial paper is used as a financial instrument and its role in the US financial markets.
  • Commercial paper is a short-term debt instrument used by corporations and other entities to raise funds for their immediate operational needs. It is an important component of the US financial markets, particularly the money market, where these securities are traded. Commercial paper provides a flexible and cost-effective way for companies to manage their cash flow and meet their short-term financial obligations, making it a crucial financial instrument in the overall functioning of the US financial system.
• Describe the relationship between commercial paper and a company's liquidity ratios.
  • Commercial paper is an important factor in a company's liquidity position, as it is considered a liquid asset. Liquidity ratios, such as the current ratio and quick ratio, measure a company's ability to pay off its short-term debts with its current assets. The inclusion of commercial paper as a liquid asset can significantly impact these ratios, as it provides a readily available source of short-term funding for the company. Therefore, the use of commercial paper is closely tied to a company's overall liquidity management and its ability to meet its immediate financial obligations.
• Analyze how commercial paper can be used to finance trade credit and the implications for a company's cash management strategies.
  • Commercial paper can be used by companies to finance trade credit, which is the extension of credit by a supplier to a buyer, allowing the buyer to delay payment for goods or services. By issuing commercial paper, companies can obtain short-term financing to cover the gap between the time they receive goods or services from suppliers and the time they receive payment from their customers. This can help improve a company's cash flow management and working capital efficiency. However, the use of commercial paper to finance trade credit also carries risks, as the company must carefully manage its liquidity and ensure that it can repay the commercial paper when it matures. Effective cash management strategies, including the use of commercial paper, are crucial for companies to maintain financial stability and meet their short-term obligations.

Related terms

Liquidity Ratio: A liquidity ratio measures a company's ability to pay off its short-term debts with its current assets. Commercial paper is an important component of a company's liquidity position.

Money Market: The money market is a component of the financial market where short-term debt instruments, such as commercial paper, are traded.

Trade Credit:

Trade credit is the extension of credit by a supplier to a buyer, allowing the buyer to delay payment for goods or services. Commercial paper can be used to finance trade credit.