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.
Types of Commercial Paper
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.
Features of Commercial Paper
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.
Advantages and Disadvantages of Commercial Paper
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.
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