Commercial Paper

A commercial paper — or CP — is a short-term debt security issued by a corporation to raise cash for immediate operating needs. Maturities are typically 1 to 270 days, making CP a money market instrument. Unlike bonds, which pay semi-annual coupons, commercial paper is issued at a discount and redeemed at face value, with the discount representing the investor’s return.

How commercial paper works

A corporation with immediate cash needs might issue $100 million of commercial paper with a 30-day maturity. It offers the paper at a discount — perhaps 98.5 cents on the dollar — meaning investors pay $98.5 million to receive $100 million in 30 days.

The investor’s return is approximately 2% annualized ($1.5M discount annualized ÷ $98.5M). This is higher than the Treasury bill rate (perhaps 1.5%) to compensate for corporate credit risk.

The corporation receives $98.5 million of cash immediately, which it uses to fund operations, pay suppliers, or meet seasonal cash needs. In 30 days, it either repays the commercial paper with cash or issues new commercial paper to roll over the debt.

This “roll-over” process is crucial: if a corporation cannot refinance maturing commercial paper with new issuance, it faces a liquidity crisis. During the 2008 financial crisis, the commercial paper market froze — corporations could not roll over maturing paper and faced sudden cash needs.

The commercial paper market

The commercial paper market is a global money market with trillions of dollars outstanding. Major corporates — General Electric, Microsoft, Apple, JPMorgan Chase, and thousands of others — rely on commercial paper for working capital funding.

Most commercial paper is issued domestically (U.S. companies issuing USD paper). Significant volumes of international commercial paper (eurocommercial paper) are also issued in foreign currencies and markets.

Credit rating and market access

Only investment-grade corporations can access the commercial paper market. A corporation rated BB or lower cannot issue commercial paper because investors consider the risk too high.

Companies often maintain credit ratings specifically to preserve commercial paper access. Losing access to commercial paper would force a company to borrow at much higher rates through term loans or bonds, materially affecting its cost of capital.

Backup liquidity and credit facilities

Most commercial paper issuers arrange backup credit facilities (bank lines) to ensure they can repay maturing commercial paper even if market access deteriorates. These backup lines are expensive insurance but essential to prevent a liquidity crisis.

During the 2008 financial crisis, companies drew down backup lines in volume, straining banking system liquidity. Regulators now require banks to maintain sufficient capital and liquidity to honor these commitments.

Asset-backed commercial paper

Some commercial paper is “asset-backed” — secured by a pool of loans or receivables (similar to asset-backed securities but with short maturity). Asset-backed commercial paper (ABCP) provides funding for automotive finance, equipment leasing, and other asset-based financing.

ABCP was severely impacted during the 2008 financial crisis when the underlying assets (primarily mortgages in securitized vehicles) faced valuation uncertainty. Investors refused to roll over maturing ABCP, causing a liquidity crisis.

Post-crisis, the ABCP market is smaller and more conservative, with stricter underwriting on underlying assets.

Money market funds and retail access

Individual investors typically do not buy commercial paper directly. Instead, they access it through money market funds, which pool many commercial papers and provide daily pricing and redemption.

Money market funds hold portfolios of commercial paper, Treasury bills, and other short-term securities, offering investors a safe, liquid alternative to bank deposits (for those above FDIC insurance limits).

Comparison to other short-term instruments

Commercial paper offers higher yield than Treasury bills but carries corporate credit risk. Treasury bills are risk-free (backed by the U.S. government) but offer lower yields.

Certificates of deposit (CDs) offer yields competitive with commercial paper but are FDIC-insured (up to $250,000), making them safer for individual savers.

Repurchase agreements (repos) are collateralized borrowing, offering low risk but lower yields.

The 2008 crisis and aftermath

The commercial paper market nearly collapsed in September 2008 when Lehman Brothers failed. Investors feared counterparty risk and stopped buying corporate commercial paper. Major corporations found themselves unable to roll over maturing paper, forcing the Federal Reserve to intervene with a Commercial Paper Funding Facility.

Post-crisis, the commercial paper market recovered but with tighter spreads and shorter maturities. Companies became more conservative about relying on commercial paper and increased backup liquidity.

See also