The Basics

What is Commercial Paper?

Commercial Paper (CP) is something which has been in the news for the last month as the center of the credit crunch. If you don’t know what CP is, here’s a definition:

Commercial Paper is an unsecured debt obligation issued by corporations and banks to for short-term financing purposes, often to fund such things as accounts receivable and inventory costs. Maturities generally are from 2 to 270 days in length and the denominations cover a wide spectrum with a numerous different type of terms. The secondary market is limited where it exists at all. Most issuers are companies with high credit ratings, meaning that the investment is almost always considered relatively low risk.

That last sentence is particularly telling. It’s certainly not the way things are playing out right now. Folks who would normally purchase CP have become reluctant to do so. They are concerned that those issuing the debt won’t pay them back. As a result, the whole market has come to a screetching halt, putting a number of companies in a major bind. This action was part of the events which motivated the Fed to lower the Discount Rate, and why so many folks have been calling for a cut in the Fed Funds rate.

It is worth noting that the problems with CP issuance have primarily been among financial companies, and not really focused on non-financials. The latter have seen CP rates (what they have to pay in interest) rise a bit, but nothing near what the financials have had to deal with.

By John

Author of The Essentials of Trading