Commercial Paper As A Source Of Short-Term Financing
Typically, governments purchase CP with a buy and hold approach until maturity strategy. During market disruptions, investors face the scenario where issuers will be unable to issue new CP to refinance the maturing commercial paper and the secondary market disappears.While a secondary market exists that can be utilized for sales prior to maturity, there have been periods of disruption due to either issuer-specific events or as a result of a broader market wide disruption. To mitigate this risk, CP is usually backed by bank lines of credit.Lacking such a market, their value is based on models that are sensitive to a number of assumptions.
It has two objectives – first, to decide whether the company will have surplus cash or cash deficit; and second, whether it is of temporary or permanent nature.Single seller ABCP programs are backed by the assets of one entity, for example a corporation.Consequently, they lack the diversification of multi-seller programs.Historically, such ABCP may have had higher credit ratings than the seller company itself.However, such homogenous assets may pose concentration risk.Banks provide three kinds of loans – Single, End-of-period Payment Loan (firms pay fixed or variable interest on the loan and payback the principal sum in lump sum at the end of the loan); lines of credit (a bank agrees to lend a company any amount up to a stated maximum – it may be committed or uncommitted line of credit.In India the line of credit is usually in the form of cash credit and banks charge interest only on the actual balance utilized; and floating charge is created in favor of the bank); and bridge loans (to bridge the gap until a firm can arrange for long-term financing – the lender deducts interest in the beginning from the loan proceeds).Nationally recognized statistical rating organizations (NRSROs) routinely rate commercial paper issues and regularly review the strength of the credit quality of the issue.In some instances, CP programs have been downgraded rapidly by the NRSROs.Commercial paper (CP) is a short-term, unsecured promissory note issued by corporations typically used as a source of working capital, receivables financing, and other short-term financing needs. Originally the CP market was available as a funding source to only the highest credit quality entities.CP has maturities ranging anywhere from 1 to 270 days. However, innovations such as liquidity programs, credit enhancements, and various special legal structures have made CP a viable financing alternative for entities with lower credit ratings.