Commercial Paper

Commercial Paper (CP) is a short-term, unsecured debt instrument issued by companies, primary dealers, and all-India financial institutions to raise funds for working capital needs. It is issued at a discount to face value and redeemed at face value on maturity, with the difference being the return for the investor.

What Is Commercial Paper?

CP is a money market instrument with a maturity of 7 days to 1 year. Companies use it as a cheaper alternative to bank credit for short-term funding needs like payroll, inventory purchases, or bridge financing.

CP is issued in the form of a promissory note and is regulated by the Reserve Bank of India.

Key Features

– **Issuer**: companies with a minimum credit rating of A2 (as per CRISIL or equivalent rating agency)
– **Tenor**: minimum 7 days, maximum 1 year
– **Issued at discount**: face value is the redemption amount; actual issue price is lower
– **Minimum denomination**: Rs 5 lakh per CP
– **Investors**: banks, mutual funds, FIIs, insurance companies, and corporates; not usually available to retail investors directly

How CP Pricing Works

If a company issues a Rs 10 lakh CP at a 6% annualised yield for 90 days:
– Discount: Rs 10 lakh x 6% x (90/365) = Rs 14,795
– Issue price: Rs 10 lakh – Rs 14,795 = Rs 9,85,205
– At maturity, the investor receives Rs 10 lakh

CP vs Bank Loans

| Feature | CP | Bank Loan |
|———|—–|———-|
| Cost | Often lower | Higher |
| Collateral | None | May be required |
| Flexibility | High | Moderate |
| Investor | Institutional | Bank only |
| Credit rating | Mandatory | Not required |

Who Invests in CP?

– Mutual funds (liquid and money market funds) are major investors in CP
– Banks invest surplus funds in CP
– Insurance companies for short-term deployment

When you invest in a liquid mutual fund, a portion of the fund’s portfolio is likely in commercial paper.

Practical Example

A large consumer goods company needs Rs 200 crore for 3 months to fund a seasonal inventory build-up before Diwali. Instead of a bank overdraft at 8.5%, it issues commercial paper at 6.8% (annualised yield), saving on borrowing costs. A mutual fund buys the CP as part of its liquid fund portfolio.

Key Takeaways

– CP is a short-term unsecured debt instrument (7 days to 1 year) for corporate working capital needs
– Issued at a discount to face value; redemption at face value is the investor’s return
– Only companies with minimum credit rating A2 or above can issue CP
– Liquid and money market mutual funds are major investors in CP
– CP is cheaper than bank credit for well-rated companies and offers flexible short-term financing