Commercial Paper – Its Types and How it Works
Commercial paper refers to a short-term, unsecured promissory note. This type of debt obligation is issued by high credit ratings holders like financial institutions and large corporations as an alternative to other expensive methods of funding. Although there are several restrictions for small retail investors to purchase commercial paper, it is still possible to some extent.
Commercial paper is usually sold at a discount to its face value. It works as the best option for retail fixed-income investors who are seeking a higher rate of return on their money. It is typically issued for the financing of inventories, accounts payable, payroll, and meeting other short-term liabilities.
Commercial paper has a fixed maturity of up to 270 days in the global financial market. Commercial paper usually pays a higher rate of interest than guaranteed instruments Most of the commercial paper investors are from the banking sector, corporate and incorporated companies, individuals, and Foreign Institutional Investors (FIIs), etc. A firm can directly issue the paper to investors, or it can be done through banks or dealer banks.
There are four types of commercial papers — promissory notes, checks, drafts, and certificates of deposit (CDs). A promissory note is the most common form of commercial paper. It is a written promise to pay a certain sum of money to a specific person or entity on a specified date or on demand. Both the draft and the check are written orders to pay a specified sum of money to a designated person or entity. The main difference is that a draft is created by the merchant and authorized by the bank, while a check is created by the account holder and drawn on the bank. A certificate of deposit, on the other hand, is a promise to pay a fixed sum of money to the depositor on a specific date in the future. According to a report published by Allied Market Research, the global commercial paper market size is projected to grow with a considerable CAGR from 2023 to 2032. A wide array of factors such as rise in investment in commercial paper, increase in the adoption of digital platforms, and trade of commercial paper through digitalization is driving the growth of the market to a great extent.
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In addition, the outbreak of the COVID-19 pandemic led to boost the growth of the global commercial paper market even more. The implementation of the global lockdown led to a reduction in the demand for the products and services, which in turn, created a shortage of funds for many business enterprises. To meet the demand for short-term funds, enterprises had to opt for commercial papers, which boosted the market growth.
Author’s Bio — Suchita Gupta is an explorer, musician and content writer. While pursuing MBA, she found that nothing satisfies her more than writing on miscellaneous domains. She is a writer by day, and a reader by night. Besides, she can be found entertaining her audience on social media platforms. Find her on LinkedIn & Instagram.
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