Money Market Instruments Commercial Papers
Commercial paper is a low-cost alternative to bank loans.
It is a short term unsecured promissory note issued by corporates and financialinstitutions at a discounted value on face value.
They are usually issued with fixed maturity between one to 270 days and forfinancing of accounts receivables, inventories and meeting short termliabilities.
Say, for example, a company has receivables of Rs 1 lacs with credit period 6months. It will not be able to liquidate its receivables before 6 months.
The company is in need of funds. It can issue commercial papers in form ofunsecured promissory notes at discount of 10% on face value of Rs 1 lacs to bematured after 6 months. The company has strong credit rating and finds buyerseasily.
The company is able to liquidate its receivables immediately and the buyer isable to earn interest of Rs 10K over a period of 6 months.
They yield higher returns as compared to T-Bills as they are less secure incomparison to these bills; however chances of default are almost negligible butare not zero risk instruments.
Commercial paper being an instrument not backed by any collateral, only firmswith high quality credit ratings will find buyers easily without offering anysubstantial discounts.
They are issued by corporates to impart flexibility in raising working capitalresources at market determined rates.
Commercial Papers are actively traded in the secondary market since they areissued in the form of promissory notes and are freely transferable in dematform.
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