Question

Define and discuss the following: Commercial paper.

Answer 1

Commercial Paper (CP)- Commercial paper is an unsecured and discounted promissory note issued to finance the short-term credit needs of large institutional buyers. Banks, corporations and foreign governments commonly use this type of funding.

Commercial paper is an unsecured, short-term debt instrument issued by a corporation, typically for the financing of accounts payable and inventories and meeting short-term liabilities.

Salient features of Commercial Paper:-

• Commercial paper are issued by the companies in the form of promissory note,redeemable at par to the holder on maturity.
• Corporates are allowed to issue Commercial paper  up to  100% of their fund based working capital limits.
• The tangible net worth of the issuing company should be less than Rs 4 crores.
• Working capital (fund based) limit of the company should be less than Rs 4 Crores.
• Credit rating should be at least equivalent of P-2 of CRISIL/P2/PP2/D2 or higher from any approved rating agencies and should be more than 2 months old on the date of issue of CP.
• Cprporates are allowed to issue CP up to 100% of their fund based working capital limits.
• It is issued at a discount to face value.
• CP attracts Stamp duty.
• CP can be issued for maturities in between 15 days and less than one year from the date of issue.
• All expenses(such as dealer's fees,rating agency fee and charges for provision of stand-by facilities)for issue of CP to be borne by the issuing company.

Investors for commercial paper:

• Individual
• Banking campanies
• other corporate Bodies
• Non resident indians
• Foreign institutional Investors.

Amount of Commercial Paper:

A)The aggregate amount of CP from an issuer shall be the least of :

• Limit as approved by its Board of directors, or
• Quantum indicated by the credit rating agency for the specified rating.

B) An FI can issue CP with in the overall umbrella limit fixed by the RBI,i.e.issue of CP together with Term Money Borrowing,Term Deposit,Certificates of Deposit and Inter company deposits should not exceed 100% of its net owners funds,as per the latest audited.

Advantages:

• Cash flow management.
• Alternative for Bank Finance
• High return to investors.
• Incentive for financial strength.