Commercial paper

Commercial paper is a type of short-term, corporate zero coupon debt security. Corporations often use it to raise money for short-term needs. Investors buy commercial paper at a discount, and the issuer repays the par value at maturity.

The maximum maturity for commercial paper is 270 days. That number ties directly to a rule under the Securities Act of 1933, which we’ll cover in the primary market chapter. This law governs the sale of new issues. In general, issuers must register securities with the SEC before selling them to the public. Registration is designed to require issuers to disclose all important (material) facts so investors have enough information to make informed decisions.

Registration can take significant time and money. Issuers typically hire lawyers, accountants, and other professionals to prepare the SEC registration form. They also pay a filing fee to the SEC. Because of these costs, issuers generally avoid registration unless it’s required.

The SEC allows certain exemptions (exceptions) from registration. Several exemptions are important and will be covered in the primary market chapter. For now, focus on this one: If a bond is issued with 270 days or less to maturity, the issuer is exempt from registering it with the SEC.

So why doesn’t the SEC require corporate issuers to register commercial paper? One reason is that short-term debt generally carries less risk than long-term debt. For an investor to lose the entire investment, the issuer would need to go bankrupt within the next 270 days. For the typical issuers of commercial paper - larger, well-established companies - that’s considered unlikely.

Commercial paper gives issuers short-term cash and, because it avoids registration, it’s relatively straightforward to issue. But the issuer must repay the borrowed funds within 270 days, so commercial paper isn’t a good fit for companies seeking long-term financing.

Typical investors in commercial paper are large institutions. Because commercial paper is issued in large denominations, typically $100,000 or more, many retail investors can’t buy it directly. However, large financial institutions may buy commercial paper and repackage it into more affordable investments for retail investors. You’ll see how this works when we discuss investment companies in a future chapter.