With CP as a debt instrument, the commercial paper market has become a component of the Indian money market. Here, the balance between supply and demand is met by two sections of people –
Issuers (who create supply)
Subscribers (who create demand)
These two promotes the market and help companies accumulate funds for their short-term financial liabilities or obligations at times of financial crisis.
These can be broadly categorised into two parts depending upon the security it offers.
Secured Commercial Papers – These are often known as Asset-backed commercial papers (ABCP) wherein it is backed by physical assets like trade receivables, etc.
Unsecured Commercial Papers – In this unsecured kind, the paper isn’t backed by pledging any asset and is allotted without any security.
Subsequently, the Uniform Commercial Code (UCC) has divided the commercial paper in India into four categories, as mentioned below.
Draft – It is written by one individual to another (usually banks) asking to pay a definite sum to the third party. A drawer, drawee, and acceptor are involved in the process. It can be of two kinds – sight draft and time draft.
Note – Also known as a promissory note, these are written by specifying the amount to be paid after a certain amount of time. Here two parties are involved – promisor (maker) and promisee (payee).
Cheque – Like drafts, these are written in paper forms where the drawee is a bank.
Certificates of Deposit – Often known as CD, this is an acknowledgement form issued by the bank confirming receipt of the deposit. Some of the difference between commercial paper and certificate of deposit is in terms of issuer, denomination, etc.
It is a short-term debt instrument tool which is set for a maturity period.
It is usually an unsecured debt where the company doesn’t pledge any asset but still qualifies for it based on their company’s liquidity, revenue-generating power, and achievements.
The commercial paper issuer guarantees or promises to pay the fixed amount to the subscriber in cash in future.
This paper can be used as a certificate of unsecured debt.
Mentioned below are some pointers that discuss the merits and demerits of commercial paper. Have a look at these pointers to understand when it is beneficial to avail this paper.
Since it is mostly unsecured in nature, your company’s assets aren’t on risk.
The method is a quick way to raise funds for working capital. It is a cost-effective method, as well as cheaper than bank loans.
The range of maturity varies, which makes it flexible.
Companies may save extra cash and convert them into good returns to save more through the process.
Customisable maturity range makes the process feasible for companies. Issuers can pay for the matured papers by selling new commercial paper.
Even though the commercial paper has several advantages in the Indian market, there can be scenarios that make it inconvenient for certain companies. The amount for which a commercial paper is made quite high, and since these are unsecured debt, only a few renowned blue-chip and profitable companies can subscribe to this. Besides, the credit available from a bank or financial institutions may get reduced after issuing the paper.
Despite a few limitations, this has helped bring the financial reform in India and helped companies overcome the financial crisis. You can learn in detail about various such concepts included in the syllabus by visiting Vedantu’s website.
1. What is Commercial Paper?
It is a short-term debt instrument issued by the financial companies to various eligible companies which need immediate funds for their short-term liabilities. These are usually unsecured in nature and are used to collect funds from financial companies or the public.
2. Who Issues Commercial Paper?
Commercial paper is issued by banks and financial companies to keep a balance on their short-term receivables and obligations. In India, Primary Dealers (PD) and All-India Financial Institutions (FIs) primarily issue this paper.
3. How to Buy Commercial Paper in India?
Commercial papers are traded amongst large institutions with significant investment amounts. However, individuals can also buy these through a dealer or via the financial institution. But their organisation should have high earning capability, liquidity, and should be renowned.
4. What is the Commercial Paper Market?
Commercial paper is a component of the Indian money market wherein the large corporations having a deficit of liquid funds to meet the short-term obligations invest in a debt instrument. This helps them evade the financial crisis situation and ensure they have enough liquid funds or working capital to carry the business operation.
5. Who Buys Commercial Papers?
Large companies, as well as individuals, can buy these commercial papers. Individuals can buy these from a broker, but the amount for investment is significant.
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