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      Understanding A-Z of Commercial Paper

      • 5 min read
      • Last Modified Date: April 30, 2024
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      • Commercial Paper (CP) is a widely used financial instrument in India that serves as a convenient and cost-effective means for corporations to raise short-term funds.
      • This comprehensive guide will explore the A-Z of Commercial Paper in India, covering its definition, key features, benefits, risks, and the regulatory framework governing its issuance and trading.
      • Whether you are an investor looking to diversify your portfolio or a business seeking efficient financing solutions, understanding Commercial Paper can be crucial for making informed financial decisions.
      • Seeking the ideal avenue to invest your hard-earned money for monthly income and high returns? Look no further than commercial real estate structured debt. With as little as 10 lakhs, you can invest through reputable alternative investment platforms like Assetmonk.
      • Take advantage of this lucrative opportunity to potentially maximize your returns and secure a steady stream of monthly income.

      What is Commercial Paper?

      • Commercial Paper meaning or commercial paper is a type of unsecured, short-term debt instrument issued by corporations, primary dealers, and all-India financial institutions to raise funds for their working capital requirements and other short-term financial obligations.
      • In India, the maturity period of a commercial paper usually ranges from 7 days to 1 year, making it an attractive option for entities that need quick access to funds without committing to long-term borrowing.

      Commercial Paper Example

      • One example of commercial paper in India is the 180-day Commercial Paper issued by the prestigious State Bank of India (SBI). This short-term debt instrument is highly sought after by investors due to its attractive features and benefits.
      • The Commercial Paper offered by SBI does not require any collateral, providing investors with the assurance of unsecured debt.
      • With a credit rating of AA+, the SBI Commercial Paper demonstrates a high level of creditworthiness, reducing the risk of default for investors.
      • Moreover, the instrument offers a competitive interest rate of 5.85%, making it an appealing option for those seeking higher yields compared to traditional bank deposits.

      Key Features of Commercial Paper

      1. Maturity Period

      Commercial Paper in India comes with a short-term maturity, offering flexibility to issuers in managing their cash flow and financial commitments.

      2. Unsecured Nature

      Unlike some other debt instruments, Commercial Paper in India is usually issued on an unsecured basis, which means there is no specific collateral attached to it. The creditworthiness of the issuer plays a significant role in determining the interest rate.

      3. Issuer Eligibility

      Who can issue commercial paper in India? Commercial paper can be issued by only well-established and creditworthy entities, as specified by the Reserve Bank of India (RBI).

      4. Transferability

      Commercial Paper in India is a negotiable instrument and can be transferred from one entity to another through endorsement, enhancing its liquidity and tradability in the secondary market.

      Types of Commercial Paper

      • Commercial Paper (CP) is a short-term debt instrument issued by various entities to raise funds for their short-term financing needs.
      • The types of commercial paper can vary based on the issuing entity and the features of the instrument. Here are the main types of commercial paper:

      1. Corporate Commercial Paper

      Corporate Commercial Paper is the most common type and is issued by large corporations with strong credit ratings. These corporations use commercial paper to finance their short-term working capital requirements, manage cash flow fluctuations, and meet other immediate financial obligations. Corporate Commercial Paper typically offers competitive interest rates due to the creditworthiness of the issuing corporations.

      2. Financial Institution Commercial Paper

      Financial institutions, such as banks, may issue Commercial Paper to fulfill their short-term funding needs. This type of commercial paper is often referred to as Bank Commercial Paper. Banks issue commercial paper to manage their liquidity, meet regulatory requirements, and bridge temporary funding gaps. As with Corporate Commercial Paper, Bank Commercial Paper also tends to have high credit ratings, making it a relatively low-risk investment option.

      3. Asset-backed Commercial Paper (ABCP)

      Asset-backed Commercial Paper is a specific type of commercial paper that is backed by a pool of financial assets, such as loans, receivables, or other financial instruments. These assets act as collateral, providing additional security to investors. ABCP is commonly issued by special purpose vehicles (SPVs) or financial institutions and is often used to finance specific projects or portfolios.

      4. Dealer Commercial Paper

      Dealer Commercial Paper is issued by primary dealers or market makers. These entities facilitate the trading of various financial instruments and participate in government securities auctions. Dealer Commercial Paper is primarily used to meet regulatory requirements, enhance liquidity management, and support market-making activities.

      5. Non-Bank Finance Company Commercial Paper

      Non-Bank Finance Companies (NBFCs) may issue Commercial Paper to raise funds for their short-term financing needs. NBFC Commercial Paper allows these financial entities to diversify their funding sources beyond traditional bank loans and other debt instruments.

      6. Sovereign Commercial Paper

      Sovereign Commercial Paper is issued by governments or government-related entities to raise funds for short-term financing requirements. These instruments are backed by the full faith and credit of the government, making them highly secure and offering competitive interest rates.

      7. Euro Commercial Paper (ECP)

      Euro Commercial Paper is issued in currencies other than the domestic currency of the issuer. It allows entities to tap into international markets for short-term funding and provides an avenue for international investors to diversify their portfolios.

      Commercial Paper Vs Certificate of Deposit

      What is the difference between commercial paper and certificate of deposit?

      CriteriaCommercial PaperCertificate of deposit
      IssuerCorporations, Financial Institutions, Government Entities, etc.Banks and select financial institutions
      Maturity PeriodUsually ranges from 7 days to 1 year in IndiaFixed terms, typically from a few months to several years
      Credit RiskHigher credit risk if issued by less creditworthy entitiesConsidered safe due to being issued by banks and regulated financial institutions
      Collateral UnsecuredNo specific collateral attached to itBacked by the issuing bank’s assets, making them secured instruments
      Secondary MarketTradable in the secondary market through endorsementNon-transferable, CD is held until maturity
      Interest RatesGenerally offers higher interest rates due to higher credit risklower interest rates compared to CP due to higher safety
      Minimum InvestmentCommercial paper minimum amount may range from ₹5 lakhs to ₹1 crore or moreMinimum investment amounts can vary depending on the issuing bank
      Risk and ReturnHigher risk due to credit quality but offers potentially higher returnsLower risk with relatively lower returns, suitable for risk-averse investors
      PurposeUsed for short-term financing needs and working capital requirementsUsed by banks to raise funds and manage liquidity
      Investor AccessAvailable to institutional and individual investorsAccessible to individual investors through banks and financial institutions

      Difference between Commercial Bill and Commercial Paper

      What is the difference between commercial paper and commercial bill?

      CriteriaCommercial BillCommercial Paper
      Nature of InstrumentA negotiable instrument used for short-term financing of trade transactionsA short-term debt instrument used to raise funds for working capital needs and other short-term obligations
      IssuerIssued by sellers or suppliers (creditors) to buyers (debtors) in the course of trade transactionsIssued by corporations, financial institutions, and government entities to investors in the financial market.
      Maturity Period30 days to 180 days7 days to 1 year
      Secondary MarketCommercial bills are not typically traded in the secondary market in IndiaCommercial Paper is tradable in the secondary market
      AccessibilityAccessible to parties involved in trade transactions and financial institutionsAccessible to both institutional and individual investors through financial platforms
      Risk and ReturnGenerally considered less risky due to the underlying trade transaction and shorter maturityhigher risk depending on the creditworthiness of the issuer but can offer competitive returns.
      CollateralCommercial bills are often backed by the underlying trade transaction and the creditworthiness of the debtorCommercial Paper is typically unsecured, relying on the creditworthiness of the issuer.

      Advantages of Commercial Paper 

      1. Cost-Effective Financing

      Commercial Paper in India often offers lower interest rates compared to traditional bank loans, providing a cost-effective means of raising short-term funds.

      2. Quick Access to Funds

      Issuers can quickly raise funds by issuing Commercial Paper, enabling them to meet immediate financial requirements.

      3. Diversification for Investors

      Investors can diversify their investment portfolio by including short-term debt instruments like Commercial Paper, thereby reducing overall risk.

      4. High Credit Quality

      Commercial Paper in India is typically issued by reputed entities with strong credit ratings, lowering the risk of default for investors.

      Disadvantages of Commercial Paper 

      While Commercial Paper offers various advantages, it is essential to consider the associated risks:

      1. Credit Risk

      The primary risk is credit risk, which refers to the possibility of the issuer defaulting on payment. Investors should assess the creditworthiness of the issuing entity before investing.

      2. Market Risk

      Fluctuations in interest rates and general market conditions can impact the market value of Commercial Paper in the secondary market.

      3. Liquidity Risk

      Although Commercial Paper is relatively liquid, market conditions or adverse events may affect the ease of selling the instrument before maturity.

      Regulatory Framework for Commercial Paper in India

      The issuance and trading of Commercial Paper in India are regulated by the Reserve Bank of India (RBI) under the guidelines provided in its Master Directions. Some key regulatory aspects include:

      Eligibility Criteria

      Only companies with a tangible net worth and a good credit rating are eligible to issue Commercial Paper in India.

      Maturity Period

      The minimum maturity period for Commercial Paper in India is 7 days, while the maximum is one year from the date of issue.

      Limit on Issuance

      The total amount of Commercial Paper that an issuer can have outstanding at any point in time is subject to a cap as a percentage of its working capital borrowings.

      Investment by Investors

      Commercial Paper in India can be held by individuals, banks, corporations, trusts, and other eligible entities.

      Reporting Requirements

      Issuers of Commercial Paper need to submit periodic reports to the RBI regarding their issuance and outstanding amounts.

      How to Buy Commercial Paper in India

      Investing in Commercial Paper in India is relatively straightforward:

      Evaluate Credit Rating

      Before investing, carefully evaluate the credit ratings of the issuer to gauge their creditworthiness and risk of default.

      Approach Financial Institutions

      Investors can approach banks, primary dealers, and financial institutions to buy Commercial Paper directly.

      Utilize Demat Accounts

      Investors can also hold Commercial Paper electronically through their Demat accounts, which offers convenience and security.

      Monitor Market Conditions

      Regularly monitor market conditions, interest rates, and the overall economic environment to make informed investment decisions.

      Bottom Line

      Commercial Paper in India is an essential financial instrument that benefits both issuers and investors. With its short-term nature, lower interest rates, and high credit quality, Commercial Paper offers a win-win situation for businesses seeking quick financing solutions and investors looking to diversify their portfolios with relatively safe debt instruments.

      Assetmonk stands out as a specialized alternative investment platform in India, offering investors access to a variety of lucrative opportunities. From commercial real estate structured debt to other alternatives, the platform carefully curates diverse investment avenues. With a minimum investment threshold of 10 lacs, Assetmonk opens doors for investors to exclusive opportunities.

      By directing funds through the platform, investors can potentially achieve an impressive Internal Rate of Return (IRR) of 18 percent. This attractive rate showcases Assetmonk’s dedication to providing investors with the potential for substantial returns on their investments.

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      3. How To Invest 10 Lakhs Rupees For Monthly Income in 2023 India

      FAQs

      Q1. What is commercial paper?

      A. Commercial Paper meaning or commercial paper is a type of unsecured, short-term debt instrument issued by corporations, primary dealers, and all-India financial institutions to raise funds for their working capital requirements and other short-term financial obligations. In India, the maturity period of a commercial paper usually ranges from 7 days to 1 year, making it an attractive option for entities that need quick access to funds without committing to long-term borrowing.

      Q2. What is an example of commercial paper?

      A. One example of commercial paper in India is the 180-day Commercial Paper issued by the prestigious State Bank of India (SBI). The Commercial Paper offered by SBI does not require any collateral, providing investors with the assurance of unsecured debt. With a credit rating of AA+, the SBI Commercial Paper demonstrates a high level of creditworthiness, reducing the risk of default for investors. Moreover, the instrument offers a competitive interest rate of 5.85%, making it an appealing option for those seeking higher yields compared to traditional bank deposits.

      Q3. How to buy commercial paper in India?

      A. You can buy commercial paper in India via the following ways:

      Investing in Commercial Paper in India is relatively straightforward:

      • Evaluate Credit Rating: Before investing, carefully evaluate the credit ratings of the issuer to gauge their creditworthiness and risk of default.
      • Approach Financial Institutions: Investors can approach banks, primary dealers, and financial institutions to buy Commercial Paper directly.
      • Utilize Demat Accounts: Investors can also hold Commercial Paper electronically through their Demat accounts, which offers convenience and security.
      • Monitor Market Conditions: Regularly monitor market conditions, interest rates, and the overall economic environment to make informed investment decisions.

      Q4. Who can issue commercial paper in India?
      A. Only well-established and creditworthy entities, as specified by the Reserve Bank of India (RBI), are eligible to issue Commercial Paper in India. These include Corporations, Financial Institutions, Government Entities, etc.

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