Academic journal article Economic Quarterly - Federal Reserve Bank of Richmond

Commercial Paper

Academic journal article Economic Quarterly - Federal Reserve Bank of Richmond

Commercial Paper

Article excerpt

Commercial paper is a short-term unsecured promissory note issued by corporations and foreign governments. For many large, creditworthy issuers, commercial paper is a low-cost alternative to bank loans. Issuers are able to efficiently raise large amounts of funds quickly and without expensive Securities and Exchange Commission (SEC) registration by selling paper, either directly or through independent dealers, to a large and varied pool of institutional buyers. Investors in commercial paper earn competitive, market-determined yields in notes whose maturity and amounts can be tailored to their specific needs.

Because of the advantages of commercial paper for both investors and issuers, commercial paper has become one of America's most important debt markets. Commercial paper outstanding grew at an annual rate of 14 percent from 1970 to 1991. Figure 1 shows commercial paper outstanding, which totaled $528 billion at the end of 1991. (Figure 1 omitted)

This article describes some of the important features of the commercial paper market. The first section reviews the characteristics of commercial paper The second section describes the major participants in the market, including the issuers, investors, and dealers. The third section discusses the risks faced by investors in the commercial paper market along with the mechanisms that are used to control these risks. The fourth section discusses some recent innovations, including asset-backed commercial paper, the use of swaps in commercial paper financing strategies, and the international commercial paper markets.


The Securities Act of 1933 requires that securities offered to the public be registered with the Securities and Exchange Commission. Registration requires extensive public disclosure, including issuing a prospectus on the offering, and is a time-consuming and expensive process.(1) Most commercial paper is issued under Section 3(a)(3) of the 1933 Act which exempts from registration requirements short-term securities as long as they have certain characteristics.(2) The exemption requirements have been a factor shaping the characteristics of the commercial paper market.

One requirement for exemption is that the maturity of commercial paper must be less than 270 days. In practice, most commercial paper has a maturity of between 5 and 45 days, with 30-35 days being the average maturity. Many issuers continuously roll over their commercial paper, financing a more-or-less constant amount of their assets using commercial paper. Continuous rollover of notes does not violate the nine-month maturity limit as long as the rollover is not automatic but is at the discretion of the issuer and the dealer. Many issuers will adjust the maturity of commercial paper to suit the requirements of an investor.

A second requirement for exemption is that notes must be of a type not ordinarily purchased by the general public. In practice, the denomination of commercial paper is large: minimum denominations are usually $100,000, although face amounts as low as $10,000 are available from some issuers. Because most investors are institutions, typical face amounts are in multiples of $1 million. Issuers will usually sell an investor the specific amount of commercial paper needed.

A third requirement for exemption is that proceeds from commercial paper issues be used to finance "current transactions," which include the funding of operating expenses and the funding of current assets such as receivables and inventories. Proceeds cannot be used to finance fixed assets, such as plant and equipment, on a permanent basis. The SEC has generally interpreted the current transaction requirement broadly, approving a variety of short-term uses for commercial paper proceeds. Proceeds are not traced directly from issue to use, so firms are required to show only that they have a sufficient "current transaction" capacity to justify the size of the commercial paper program (for example, a particular level of receivables or inventory). …

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