Commercial Papers Short-term Debt Instrument
Source Commercial Papers Short-term Debt Instrument: Financial Express
GS III: Economy
Overview
- News in Brief
- What are Commercial Papers (CPs)?
- What is a bond?
- In summary
Why in the News?
Rates on CPs are expected to remain elevated in the near term because the RBI has made it very clear that it will continue to suck out excess liquidity from the banking system
News in Brief
- Rates on commercial papers (CPs) with short-term maturity have risen sharply in the past two months as the Reserve Bank of India (RBI) has tightened the leash on liquidity.
- CP rates with a maturity of two-three months have surged nearly 40 basis points since August, hitting non-banking financial companies (NBFCs) the most.
- High CP rates are not good news for companies as it raises the cost of short-term funds for them.
- National Securities Depository Limited (NSDL) data
- Companies raised Rs 91,764 crore through 381 CP issuances in July while in September.
- They raised `1.21 trillion in September, indicating a high supply of these papers.
What are Commercial Papers (CPs)?
- Commercial Papers (CPs) are short-term debt instruments issued by corporations, financial institutions, and sometimes even the government to raise funds for a short period, typically ranging from a few days to a year.
- They are an essential part of the money market, providing a way for entities to meet their short-term financing needs.
Commercial Papers as a short-term debt instrument
- Issuer
- Typically, large, creditworthy corporations with a strong credit rating issue commercial papers.
- Financial institutions like banks and non-banking financial companies (NBFCs) also use CPs as a means of raising short-term funds.
- In some cases, the government might issue CPs to manage its short-term cash flow.
- Maturity
- Commercial Papers have a short maturity period, usually ranging from a few days to a maximum of 365 days (1 year).
- They are categorized into three types based on their maturity: overnight (1 day), 7-30 days, and 31-365 days.
- Purpose
- CPs are typically used to cover short-term funding needs, such as managing working capital, financing accounts receivables, or meeting short-term liabilities.
- They are not intended for long-term financing or capital expenditure.
- Denomination
- Commercial Papers are issued in denominations typically ranging from INR 5 lakh (or multiples thereof) to meet the needs of institutional investors.
- Discount Instrument
- CPs are usually issued at a discount to their face value. Investors purchase them at a lower price and receive the face value upon maturity.
- The difference between the face value and the purchase price represents the interest earned by the investor.
- Secondary Market
- While CPs are typically held until maturity, they can also be sold in the secondary market before their maturity date.
- This allows investors to liquidate their investments if needed.
- Credit Rating
- Investors pay close attention to the creditworthiness of the issuer because CPs are unsecured.
- Credit rating agencies assess and assign ratings to CP issues based on the issuer’s creditworthiness.
- Higher-rated CPs usually have lower yields.
- Regulation
- The issuance of Commercial Papers in India is regulated by the Reserve Bank of India (RBI).
- Issuers must adhere to RBI guidelines, including credit rating requirements.
- Liquidity
- CPs offer high liquidity, making them attractive to investors.
- They can be easily traded in the secondary market before maturity, allowing investors to adjust their portfolios as needed.
- Tax Implications
- The returns from CPs are subject to taxation as per the investor’s tax bracket.
- This is important for investors to consider when assessing the overall returns from their CP investments.
What is a bond?
- Bonds are long-term debt instruments that companies issue to finance their long-term liabilities such as capital expenditures, acquisitions, and other long-term investments.
- Bond prices are inversely correlated with interest rates: when rates go up, bond prices fall and vice-versa.
- A bond is referred to as a fixed-income instrument since bonds traditionally pay a fixed interest rate (coupon) to debtholders.
In summary
- Commercial Papers are a short-term debt instrument used by entities to raise funds for a brief period.
- They are attractive to investors seeking short-term, low-risk investment options while providing issuers with a means of meeting their immediate financing needs.
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