Businesses always need funds to keep their daily operations running smoothly. These needs include buying raw materials, paying workers, and handling bills. To manage such short-term requirements, companies often use a special financial tool. Commercial paper is a short-term debt instrument. Big companies use it to borrow money for a few weeks or months. It is issued at a discount and repaid at face value. It does not need any security like property or gold. Companies with strong credit ratings use it to raise quick funds. Commercial paper is very popular in India. Banks, mutual funds, and financial institutions invest in it. The Reserve Bank of India (RBI) sets the rules. It ensures that only safe and reliable companies can issue it. Investors trust commercial paper because it is short-term and offers good returns.
What is Commercial Paper?
Commercial paper is a tool that helps companies get money for short periods. It is a promise made by the company to repay the borrowed amount after a few days or months.Commercial paper is a money market instrument. It is an unsecured, short-term promissory note. Companies issue it to meet working capital needs. Since it is unsecured, only firms with strong financial health can issue it. Investors trust it because it carries a good credit rating.
Key Features of Commercial Paper
Commercial paper has many special features that make it useful for both companies and investors. These features show how it works, who can use it, and why it is trusted in finance.
Unsecured Nature:
Commercial paper does not need any security like land or gold. It is based on the company’s reputation and credit rating. Only firms with strong records can issue it.
Short Tenure:
The maturity period of commercial paper ranges from 7 days to 1 year. It helps companies manage urgent or seasonal cash needs without long-term commitments.
Issued at Discount:
Companies issue it at a lower price than its face value. On the maturity date, the investor receives the full amount. The difference becomes the investor’s profit.
Credit Rating is Required:
Every company must get a rating from a trusted credit agency. This shows how safe the investment is. It helps investors decide whether to buy it.
Issued in Demat Form:
Commercial paper is issued and traded in electronic form. This makes the process faster and safer for everyone.
Used for Working Capital:
Companies mostly use commercial paper to cover short-term expenses. These can include buying goods, paying bills, or covering seasonal demands.
Types of Commercial Paper
Understanding the different types of commercial paper helps investors and companies choose the right option for their needs. These types differ based on who issues them and how they are structured.
Based on the Issuer
Corporate Commercial Paper:
Large businesses issue this type to fund their working capital. These papers are popular in the market and trusted due to the company’s reputation.
Bank-Issued Commercial Paper:
Banks may also issue commercial paper to meet temporary liquidity shortages. They offer a reliable source for investors looking for low-risk returns.
NBFC Commercial Paper:
Non-banking financial companies issue these to manage loans or asset purchases. They are preferred when credit conditions are favorable.
Based on Market
Primary Market Paper:
Issued directly by the company to the investor. It helps companies raise fresh funds without involving brokers.
Secondary Market Paper:
This paper has already been issued and is now being traded between investors. It allows buyers to invest without waiting for new issues.
Based on Form
Promissory Notes:
These are simple written promises to pay the investor a fixed amount at maturity. They are easy to understand and trade.
Drafts and Bills:
Some companies use more structured formats like drafts. These include specific terms and conditions.
How Does Commercial Paper Work?
Understanding how commercial paper works helps you see the flow of money from the issuer to the investor and back. It is a smooth, step-by-step process.
Step-by-Step Process
Step 1: Company Needs Funds:
A company faces a short-term cash gap. It decides to raise money by issuing commercial paper. This helps avoid taking a bank loan.
Step 2: Credit Rating:
The company gets a credit rating from a trusted agency. This shows that it is financially strong and reliable to investors.
Step 3: Setup Process:
The company chooses the amount, duration, and rate. It also appoints a registrar to manage the issue.
Step 4: Offer to Investors:
The company sells the commercial paper at a discount. Investors pay less than the face value.
Step 5: Redemption at Maturity:
On the maturity date, the company pays the full value to the investor. The difference becomes the investor’s profit.
This process allows companies to meet their short-term needs and investors to earn quick returns with low risk.
Who Can Issue and Invest in Commercial Paper?
Not every company or person can issue or invest in commercial paper. RBI sets rules to make sure that only safe and qualified parties can take part.
Who Can Issue?
Large Corporates:
Only companies with a strong credit rating and positive financial history can issue commercial paper. This reduces the risk of default.
Financial Institutions:
Institutions like NBFCs and primary dealers use commercial paper to meet their funding needs. They follow all regulatory norms.
Banks:
Scheduled commercial banks may also issue commercial paper when they face a short-term liquidity gap.
Who Can Invest?
Banks and Mutual Funds:
These investors have experience and large capital. They often buy commercial papers in bulk.
Insurance and Pension Funds:
These long-term investors use commercial paper to park their surplus funds temporarily.
Corporates and FIIs:
Big companies and foreign institutional investors prefer commercial paper due to its short duration and safety.
Advantages of Commercial Paper
Commercial paper offers many benefits to both issuers and investors. It provides quick access to money and a good return on idle funds.
For Companies
Cost-Effective:
Companies can raise funds at a lower interest rate compared to bank loans. This helps save money and improve profitability.
Faster Access:
The process is quick. Companies can get funds without lengthy paperwork and approvals.
No Security Required:
Companies do not need to pledge assets. Only a good credit rating is needed, which makes it easier to issue.
For Investors
Higher Return:
Investors get better returns than fixed deposits. This makes commercial paper an attractive option for short-term parking of funds.
Short-Term Commitment:
The maturity is short, usually within a year. It suits investors who want liquidity.
Safe with Ratings:
Since only rated companies can issue it, the risk is lower. Investors can trust the paper if the rating is high.
Disadvantages and Risks of Commercial Paper
Like all financial tools, commercial paper has some risks. Understanding these helps in making safer investment choices.
For Companies
Only for Big Firms:
Small businesses cannot issue commercial paper due to strict rules. They have to depend on traditional loans.
No Renewal:
Once issued, it must be repaid at maturity. It cannot be rolled over like a bank overdraft.
Market Sensitivity:
Changes in interest rates or investor mood can affect demand. This may make it harder to sell.
For Investors
Credit Risk:
If the company fails to repay, investors can lose money. There is no security to fall back on.
Large Investment Size:
Retail investors may not have enough capital to invest. It is mainly for big players.
No Regular Interest:
Investors earn only once at maturity. There is no monthly income like in bonds or FDs.
Real-Life Use Cases of Commercial Paper in India
Commercial paper is widely used in India by top companies. They use it as a bridge for short-term fund requirements.
Tata Motors:
Tata Motors used commercial paper in 2021 to meet working capital needs. It helped them cover short-term gaps without affecting long-term plans.
LIC Housing Finance:
This company regularly uses commercial paper to handle disbursement schedules. It helps manage cash flow smoothly.
Reliance Industries:
Reliance uses commercial paper as part of its financial planning. It reduces the cost of borrowing and increases efficiency.
These examples show that commercial paper is a practical tool for strong, well-managed firms.
What is Commercial Paper FAQs
Q1. What is commercial paper in simple words?
It is a short-term tool companies use to borrow money for a few weeks or months.
Q2. Who can issue commercial paper in India?
Large companies, NBFCs, and banks with good credit ratings can issue it.
Q3. Is commercial paper safe?
Yes, if the company has a good credit rating. Still, investors must check ratings carefully.
Q4. Can a small investor buy commercial paper?
Usually no. The investment size is large, and it’s mostly for big investors.
Q5. How do companies repay commercial paper?
They pay the full face value to the investor on the maturity date without any interest in between.
