Commercial paper is a short-term unsecured debt instrument with a maturity date of less than 270 days. Financial institutions and large companies issue commercial paper to meet their short-term financing needs.
Characteristics of Commercial Paper Lending
- Used to fund working capital (e.g., inventory, wages, operating expenses, etc.)
- Offered in denominations of $100,000 or $250,000
- Not purchased by the general public
- The average outstanding maturity is 60 days
The issuer can structure commercial paper as either discounted commercial paper or interest-bearing commercial paper. Discounted commercial paper works similarly to a zero-coupon bond, where the debt instrument does not pay regular interest income because it is issued at a discount from face value. The discount represents the interest income to the investor when the note matures.
Example Commercial Paper Transaction
Company ABC Inc. (the “Company”) is a large publicly traded corporation looking to borrow $10,000,000 to finance its short-term working capital needs.
The Company works with a large financial institution to complete the transaction. The terms of the commercial paper notes are the following:
- Face value $10,000,000
- Maturity period of 30 days
- Issue Price: $9,950,000
- Discount: $50,000
The Company will receive $9,950,000 of cash from the financial institution. Thirty days from the date of issuance, the commercial paper matures, and the Company must deliver $10,000,000 as repayment for the debt. The $50,000 discount is the interest income the financial institution earns on the transaction.