Commercial paper

Commercial paper is a type of short-term, corporate zero coupon debt security. If a corporation needs to raise money for short-term purposes, issuing commercial paper is a great way to do it. Investors purchase commercial paper at a discount and the issuer pays back the par value at maturity.

The maximum maturity for commercial paper is 270 days. It may seem like a random amount of time, but it relates to something specific. In the primary market chapter, we’ll discuss the Securities Act of 1933, which is a law that covers the sale of new issues. Issuers are typically required to register securities with the SEC prior to public sale. The purpose of registration is to force issuers to disclose all important (material) facts about the security in order to provide the public with enough information to make an informed investment decision.

Registration involves significant amounts of time and money. The issuer will hire lawyers, accountants, and other professionals to help them fill out the SEC’s registration form. In addition, the issuer must pay a fee to the SEC just to file the form. This is an exhausting process that is only done if absolutely required.

The SEC provides exemptions (exceptions) to their registration process. There are a number of exemptions that are important to know and will be discussed in the primary market chapter. For now, we’ll only focus on one of them. If a bond is issued with 270 days or less to maturity, the issuer is exempt from registering it with the SEC.

Why doesn’t the SEC require corporate issuers to register commercial paper? Short-term bonds are usually very safe and avoid many of the risks that investors assume with long-term bonds. In order for the purchaser to lose their entire investment, the issuer would need to go bankrupt within the next 270 days. This is unlikely to happen for most larger, well-established companies, which are the typical issuers of commercial paper.

Commercial paper provides issuers with short-term cash. By avoiding the registration process, issuing this type of debt is a fairly simple process. Issuers must repay the borrowed funds within 270 days, so issuing commercial paper isn’t a great option for a company looking for long-term funding.

Typical investors in commercial paper are large institutions. Due to their large denominations, typically $100,000 or more, many retail investors cannot afford commercial paper. However, large financial institutions buy and repackage them into affordable investments for retail investors. When we discuss investment companies in a future chapter, you’ll learn more about this.