Types of Commercial Paper (Uniform Commercial Code – UCC)
Drafts are written documents of agreement involving three key parties: the drawer(lending institutions such as banks), the drawee or payer, and the payee. The drawer(the bank) instructs the payer to pay the amount mentioned in the draft to the payee within a specific amount of time.
A check is the fastest way to get short-term funding via commercial paper. Banks are the drawee or payer in these cases and are instructed by check issuing company to pay a certain amount to the payee instantly.
Notes, also known as promissory notes, are a form of short-term obligations or debt instruments. A promissory note is akin to a promise made by one party to pay a certain amount of money to another party within the due date.
4. Certificates of Deposit (CD)
These are documents of evidence that signify or assert any instance of bank deposits made by an investor in a bank. These certificates also mention the interest rates that the financial institution must pay to the investor and the date of maturity of the deposit.
Types of Commercial Papers (On The Basis of Security)
Commercial papers can also be categorised into asset-backed commercial papers & non-secure commercial papers.
Unsecured Commercial Papers
Most traditional commercial papers are unsecured. Unsecured commercial papers do not have any assets or collateral attached as security. The credit risk involved in such cases depends upon the credit rating and credibility of the issuer, alongside the value of their assets and other characteristics. Large companies with high credit ratings corporations are common entities in any commercial paper market and issue unsecured commercial paper to meet short-term liabilities.
Secured Commercial Papers
Also known as asset backed commercial paper, they are backed by the issuer’s current assets. In most cases, a commercial paper is issued by large institutions by transferring certain financial assets to a special entity known as Structure Investment Vehicle. The issued commercial papers is then rated on the basis of the asset values of the special investment vehicle, keeping any credit risk off of the sponsoring or issuing organisation.
Benefits of Commercial Papers
Benefits to Issuers
Fulfil short-term working capital needs: CPs provide an economical option to companies to fund their short-term loan needs for periods between seven days to one year. Companies can receive more funding at lower interest rates through commercial papers than loans from financial institutions.
Flexible: The terms of the CP, such as maturity, and coupon rate, can be customised as per the requirement of the issuing company. Hence, CPs are more flexible than other borrowing options such as loans.
Tax friendly: Interest on CPs is considered part of the expense to a company. So, it helps to reduce the firm’s tax liability.
Benefits to Investors
Diversification: If you have parked money in traditional debt instruments, you may invest in CPs to build a diversified short-term portfolio to fulfil short-term goals.
Lower risk than longer-term papers: CPs are short-term instruments, so they are less likely to be affected by interest rate changes than longer-term papers like bonds.
Regulated: The Reserve Bank of India (RBI) regulates CPs. So, the issuer must follow the RBI’s rules and regulations while issuing commercial papers.
Flexibility to invest across different maturities: As the maturity of a commercial paper can be anywhere between seven days to one year, investors have the option to invest in CPs that mature at different periods.
How do Commercial Papers Work?
Companies use CPs to get short-term loans for seven days to one year. The company issuing the CP agrees upon an interest rate/coupon rate basis of the requirement and credit rating of the company/issue. Investors can purchase the securities in the primary market either directly from the issuer or through distribution networks, including platforms such as Yubi, during the launch of the issue. Investors can also buy CPs in the secondary market through platforms such as Yubi before the tenure of the instrument expires.
The interest rate of the CP is linked to the creditworthiness of the underlying issuer. So, a company with a good credit rating can raise money at a lower interest rate than a company with a lower credit rating by issuing commercial papers.
Companies can issue CPs in two varieties. The first is at face value with interest/coupon. The other more popular version is when the paper’s face value is discounted, and the discount is the interest received by the investor. Here’s an example of the second instance of discounted CP. Issuers could sell a CP with a face value of Rs 1,000 and maturity of one year at a discount rate of Rs 918 to give the investor a coupon of 9% at the time of maturity.
Individuals, non-resident Indian (NRIs), companies, banks, and foreign portfolio investors (FPIs) usually invest in CPs.
Calculate Yield of Commercial Paper
The formula to calculate the yield of a commercial paper is relatively simple.
Yield = [(Face Value – Selling Price)/Selling Price] * (360/Maturity Period) * 100
How to Invest in Commercial Paper Blue
Investment in the commercial paper market is generally restricted to institutional investors and high-net-worth individuals. This is because the denominations of issued papers are substantially large. Large corporations with high credit ratings are primary issuers, and their financial requirements are generally relatively high.
Minimum investments are quite high, and as per the Reserve Bank of India’s regulations, corporate organisations and banking institutions are the primary buyers.
Why Is It For You?
Yubi‘s bond platform Yubi Invest provides trade and investment options across various debt instruments, including CPs. The platform is a one-stop destination to trade and invest in CPs with details regarding history, yields offered, and the capability to place bids for the underlying securities.
In addition to investing and transacting, the platform also provides portfolio management services, including comprehensive risk management tracking of the underlying securities. The underlying engine behind the platform provides a single source for all the factual and trend data of the securities traded, which includes independent data validation, on-ground verification, peer-benchmarking, forensic check on financials and portfolio and sectoral insights.
Yubi Invest provides unparalleled efficiencies, including complete digitisation, a neat repository, and actionable tasks for all sales counter-parties within minutes. It also provides efficient credit, price discovery, and liquidity in the secondary debt market.
- Indian businesses have sold a record-high number of a commercial paper debt instruments and raised humongous amounts of short-term funding in 2021.
- As per RBI data, the number of fresh issuance of commercial paper jumped by 37 per cent monthly, year-on-year, to about Rs 1.71-lakh crore in June 2021.
Who buys Commercial Paper?
The Reserve Bank of India allows individuals, corporate organisations, and banking institutions to invest in & buy commercial paper in India.
No, the RBI is the regulatory body that supervises the issuing & selling of commercial paper. CPs are generally issued at a discount by businesses with high credit ratings.
The minimum limit of denominations of a commercial paper is Rs. 5 lakhs.
The minimum limit of maturity period for outstanding commercial paper lies between 7 and 15 days.
The minimum limit of a commercial paper denomination in India is currently Rs. 5 lakhs, as per the latest notify.
No, all CPs must be issued through private placements only. No issuing entity can issue one publicly.
Yes, commercial paper is liable for stamp duties as per the Indian Stamp Act 1899. Usance Promissory Notes, one of the many types of commercial paper, have stamp duty charges levied upon them.
The coupon rate is the interest offered by the CP. This coupon is usually a discount on the instrument’s face value.
Credit ratings are provided by independent credit rating agencies in the country and denote the creditworthiness of the underlying issuer. The ratings impact the coupon/interest rate. For instance, a company issuing CP with a low credit rating would require a higher coupon rate to attract investors than a higher-rated CP.
The maturity date is the period by which the CP will mature. At maturity, the CP issuer returns the capital invested in buying the securities.
A term sheet is a document associated with any fixed-income instrument, including CPs, which provides all the terms and conditions pertaining to the issuance. This will include terms regarding coupon rate, maturity date, and credit rating, among other details. A term sheet thus provides all the details required of the CP to make a qualified investment decision.
The Reserve Bank of India (RBI) is the regulatory authority for the country’s money markets, and commercial paper is a money market instrument.
Individuals, non-resident Indian (NRIs), companies, banks, and foreign portfolio investors (FPIs) may invest in CPs.