Types of Commercial Paper (Uniform Commercial Code – UCC)
1.Draft
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.
2. Check
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.
3. Note
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.
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.
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.