Sat. Aug 13th, 2022
    Commercial paper

    Commercial Paper

    Any company with cash needs can opt for commercial paper if it has bank approval and is governed by certain legal provisions. It is a method of financing in the form of a negotiable debt security (NDS) exchangeable over the counter between economic agents. Buyers are most often looking for high risk-free profitability. How exactly does this happen?

    Characteristics of commercial paper

    It is possible for a company to finance its activity otherwise, through commercial paper. In concrete terms, it is a negotiable debt security (NDS). This is issued by a company, generally a large one, in need of financing.

    The purpose of such an initiative is to encourage other economic agents in a surplus situation to buy the securities concerned. Thus, the two economic agents that come into play are beneficiaries. On the one hand, the company issuing the NDSs can continue its activity. On the other hand, the other economic agent will benefit from a privileged short-term placement (between one day and one year).

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    Issuing conditions

    It should be noted that, in order to be able to issue commercial paper, a given company must meet a certain number of conditions. For example, it must benefit from the favors of the main global rating agencies (Moody’s, Standard & Poor’s, Fitch). In fact, a company well rated by these organizations will be able to inject more NDS, at low rates, and therefore more attractive to other economic players. The cost of borrowing will therefore be lower.

    Commercial paper also has a short maturity of no more than one year. The maturity is also generally less than 3 months. This allows the company to finance itself at a lower cost.

    In practice, the market is specifically active on maturities of less than three months. Borrowing rates are specifically cheap for businesses (lower than for lines of credit). They are generally higher by a few basis points (or basis point, 1bp=0.01%) than the Eonia swap of the same maturity.

    The difference with the swap also called issue spread depends on several factors:

    – the credit quality of the issuer (the spread increases with the risk);
    – the duration of issue (the spread increases with duration);
    – the greater or lesser liquidity of the market (the spread increases when the liquidity decreases);
    – the outstanding amount issued by the issuer (the more an issuer calls on the market, the more it risks paying dearly).

    Problems

    Companies cannot easily issue commercial paper, they must meet very specific financial rating conditions established by independent bodies (companies must establish management ratings over the last six months to justify their financial health and their solvency).

    Advantages

    For business units, the purpose of issuing Commercial Paper is as an alternative source of short-term external financing which can be obtained relatively quickly and easily compared to other short-term financing sources. This objective is the basic premise for choosing Commercial Paper as a source of financing.

    In this case, of course, the business unit issuing the Commercial Paper must be able to consider whether the financing needs are short-term or long-term.

    Commercial Paper issuance usually has a choice between a number of funding sources, both short-term and medium-term funds.

    The choice will fall on Commercial Paper because the administration is relatively cheap, the instrument is relatively more flexible than other instruments (usually issued continuously so that with different maturity dates the previous Commercial Paper can be paid with Commercial Paper funds issued later), not bound on guarantees and tight national economic liquidity as indicated by the difficulty of obtaining credit facilities and high interest rates.

    Trade Items

    Trading objects that meet these requirements are government bonds such as interest- free federal treasury bills of the Federal Republic of Germany (“Bubills”, ” U- Schätze”, maximum term of 1 year) as federal securities with a minimum denomination of 0.01 euros since 2004. They have terms of six or twelve months. Other money market instruments are Switzerland ‘s money market debt register claims, US Treasury bills, British short-term gilts and corporate bonds from the non -bank sector such asDeposit certificate e (or deposit certificates; English certificates of deposit, abbreviated CD) or commercial papers.

    Money market book claims (GMBF: Geldmarktbuchforderungen)

    Are issued by the Swiss Confederation and other public authorities in Switzerland. They were first issued in 1979 and have held a firm place on the Swiss money market ever since. GMBF usually have a term of between three and twelve months and are discounted. In 2008, the Swiss National Bank introduced its own money market book claims, so-called SNB bills , to supplement its range of monetary policy instruments . These have a term of between one week and one month.

    US Treasury Bills

    US treasury bills have been issued since April 7, 2008 with a minimum denomination of 100 US dollars (before that 1,000 US dollars) discounted with a discount by the US government. They are placed on the money market by the Federal Open Market Committee.

    Certificates of Deposit

    Belong to the deposit business of the banks and are securitized time deposits in the form of a short to medium-term security that is designed as bearer paper. They originated in the USA and England, can have a fixed or variable interest rate and can be traded on the secondary market.

    Commercial paper (CP)

    Are short-term unsecured bearer bonds of the US money market, which are issued by first-class industrial and commercial companies and may have maturities of up to 270 days. There are also secured money market papers (English asset-backed commercial paper, abbreviation ABCP), which are issued by special issuing companies (conduits). As a rule, an excellent rating of the issuer is a prerequisite for placement and trading. It is is used to meet short-term capital needsissued.

    Example of Commercial Paper

    One of the examples of commercial papers are when a retail firm is looking for short-term funding to finance some new inventory for an upcoming holiday season. The firm needs $10 million and it offers investors $10.1 million in face value of commercial paper in exchange for $10 million in cash, according to prevailing interest rates.

    In effect, there would be a $0.1 million interest payment upon maturity of the commercial paper in exchange for the $10 million in cash, equating to an interest rate of 1%. This interest rate can be adjusted for time, contingent on the number of days the commercial paper is outstanding.

    A company needs funding of at least $30,000,000 and wishes to issue on the money market commercial paper of nominal value $150,000, maturity 180 days and nominal rate 4.5% prepaid. How many commercial papers should it issue?

    Answer:
    If the company issued 200 commercial paper (30,000,000 / 150,000), today it would only get a
    financing of: 30,000,000 (1 – 4.5% x 180 /360) = $29,325,000.
    To obtain at least 30,000,000 Dollars, it must therefore borrow a amount corresponding to the future value of the $30,000,000 of which it need today:
    VF = 30,000,000 / (1 – 4.5% x 180 /360) = $30,690,537.08.
    Since the commercial paper has a face value of $150,000, it it will have to issue 205 banknotes to obtain just over 30 million Dollars.

    Sources: PinterPandai, eFinance Management, Wall Street Mojo

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