Money Market Funds Investments – Commercial Paper

Commercial paper is a money market security issued by large banks and corporations.  It is generally not used to finance long term investments but more accurately to purchase inventory or for working capital.  Commercial paper may be compared as an alternative to a line of credit offered by a bank for a commercial business.  Often when a business becomes quite large, and maintains a high enough credit rating, using the commercial paper market to fund business activities is cheaper than using a bank line of credit.  Because commercial paper maturities do not exceed 270 days and proceeds typically are used only for current transactions, the notes are exempt from registration as securities with the United States Securities and Exchange Commission. 

Many companies issue commercial paper and still maintain bank lines of credit to act as a backup to the commercial paper.  Banks will charge fees for the amount of the line of the credit that does not have a balance.  While these fees may seem like pure profit for banks, if the company ever actually needs to use the line of credit it would likely be a signal of serious short term or even long term financing troubles that may lead to difficulty repaying its liabilities.

Investors lend the commercial issuer money for specified number of days at a specified interest rate.  There is also an active secondary commercial paper market.  Over a one thousand companies in the United States issue commercial paper.  Financial companies issue large quantities of commercial paper in areas such as mortgage financing, factoring, finance leasing, business lending, insurance underwriting and other investment activities.  Nonfinancial firms such as manufacturers, public utilities, industrial concerns and service industries also issue large quantities of commercial paper.

The commercial paper market consists of short term notes issued by a wide variety of corporations that include domestic and foreign firms, banks, finance companies, and other issuers of commercial paper.  Commercial paper is often unsecured, short-term debt instrument issued by the corporation.  The funds raised from the commercial paper sales is used typically for the financing of accounts receivable, inventories and meeting short-term liabilities.
 
The debt is usually issued at a discount with the implied rate of return reflecting prevailing market interest rates or the repayment risk associated with the commercial issuer.  Commercial paper is not usually backed by any form of collateral; therefore only firms with high-quality debt ratings will easily find buyers without having to offer a substantial discount for the debt issue.  Asset-backed commercial paper, which is a type of commercial paper backed by a pool of assets of the issuing business, accounts for about half of the total commercial paper outstanding.

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