Definition : Commercial Paper (CP) is an unsecured and negotiable money market instrument issued in the form of promissory note by highly rated corporate borrowers to diversify their source of short term finance. Commercial papers are usually issued at a discount from face value for a short period ranging between a minimum of 7 days and a maximum up to 1 year from the date of issue.
RBI introduced CP in the Indian market in 1990. As Commercial Papers are not backed by any collateral security, so only firms with high credit rating by recognized credit agencies like CRISIL, ICRA, CRISIL etc. can issue commercial paper.
Who can issue CP ?
- Primary Dealers (PDs)
- All India Financial Institutions (AIFIs)
Further, A corporate should meet the following criteria to issue commercial paper (CP) –
- The tangible net worth of the company, as per latest audited balance sheet is not less than 4 crore.
- Company has been sanctioned working capital limit by bank/s or all-India financial institution/s.
- Borrowal account of the company is classified as a Standard Asset by the financing bank/s institution/s.
Who can invest ?
- Banking Companies
- Corporate Bodies (Registered or incorporated in India) and Unincorporated Bodies
- Foreign Institutional Investors (FIIs) , However, investment by FIIs would be within the limits set for them by Securities and Exchange Board of India (SEBI).
Advantages of Commercial Paper
- No Collateral – CPs are sold on an unsecured basis. Hence, no security or collateral required to raise finance.
- Cheaper – As CPs are required to be rated, good credit rating reduces the cost of capital for the firm.
- High Liquidity – As it is a freely transferable instrument. It has high liquidity.
- Extra Funds – It provides extra funds as the cost of the paper to the issuing firm is cheaper than the cost of loan from commercial banks.
- Reliable – Commercial Papers are highly reliable and does not have any limiting condition.
- Continuous Source of Fund – It provide continuous source of funds. As maturity range can be customized according to company or firm’s requirement. Further, maturing CP can be repaid by selling new commercial papers.
- Good Return – Companies or Firm can earn good return on excess fund by parking it in CP.
Disadvantages of Commercial Paper
- Only financially secure and highly rated firms can raise funds through commercial papers.
- Issue of commercial paper is strictly regulated by Reserve Bank of India (RBI).
- The amount that we can raise through commercial paper is limited to the deductive liquidity available with the suppliers of funds at a particular time.
- By issuing commercial papers, the credit available from banks may get reduced.
- Commercial paper is an odd method of financing. As such if a firm is not in a position to redeem its paper due to financial difficulties, extending the duration of commercial paper is not possible.