Commercial Paper Rates

Commercial paper is an interesting investment opportunity, and one that many investors don’t even consider when looking at moderate-term secure investments. Known as a promissory investment, a commercial paper purchase involves purchasing the security to an investment issued by a company, which is in turn repaid with interest to the investors that purchased it over a 270-day total period.

Sound confusing? Don’t worry – while the concept of a ‘paper’ investment in a company may seem somewhat strange, it’s relatively simple to explain once you gain an understanding of the ways that large companies borrow money to finance expansion. To begin, let’s look at the type of loans large companies opt to take from banks, and how they differ from standard personal lending options.

When you go into a bank and ask for a loan, it’s typically of a relatively low value and is used for a house, apartment, vehicle, or other low-value purchase. That’s not to say that it’s low value to you – only that it’s a relatively low-volume loan to the bank. These loans generally come with relatively high rates of interest, particularly when compared to the bulk lending deals that many banks offer.

Let’s compare this situation to the one a major company may be in. With the economy improving, a large retail outlet company may wish to expand into new cities, new districts, and even new markets overseas. Their current capital assets aren’t enough to finance the expansion, although projections in the next few years show that they’ll be able to repay a loan for the expansion relatively quickly.

Their first point of call is a bank, in which they’re generally able to secure a large loan for expansion and required spending. The downside of this, however, is that even with the preferential rates given to such a large borrower, the total interest rate may be relatively higher than what is available on the private lending market. In short, the company may be able to secure a better interest rate elsewhere.

The company, looking for profitability in its borrowing choices, goes into the private market, where investors may offer more preferential rates for its loan. One way of doing this is for the company to offer a ‘commercial paper’ investment opportunity, in which a range of investors are able to buy the company’s loan securities, giving the company money that can be used to finance its expansion.

This means that the company itself interacts with no bank, only the investors that have purchased its paper in aims of capitalizing on its debt. The company, rather than repaying the loan to a bank, pays it directly to the investors that financed its new projects and plans. This allows the bank to secure an even greater amount of financing, often at a significantly lower interest rate than a bank may offer.

It also provides significantly better interest rates for the investors backing the loan. While a savings account is generally put directly into financing decisions made by the bank in which its placed, it’s a form of investment that produces a considerable margin for the bank itself. Commercial paper is an interesting way of ‘bypassing’ the bank in this situation, financing the loan without a middleman.

Generally speaking, all commercial paper investments are required to be repaid within 270 days of their first being issued, allowing investors a relatively short-term method of earning interest on cash or other capital. In this way, it’s frequently used as a more profitable alternative to a bank certificate of deposit investment, a money market account, or a relatively low-interest savings account.

However, it is slightly less secure than these types of investment, having no FDIC backing and little in the way of guaranteed security. That said, commercial paper is a long-lasting form of investment that’s been around for centuries. In fact, it’s often pointed to as a driving financial force behind our nation’s economy – fuelling company expenses and making innovation possible for businesses.

Commercial paper rates can vary based on the current state of non-bank lending, the projections of expansion or investment by major businesses, and the industry in which commercial paper is being purchased. Some industries, particularly those where research and development are major costs, are heavily dependent on commercial paper financing, often alongside private equity investment.

One notable example of this is American electrical goods company General Electric, which has been historically criticized for its large commercial paper financing. Due to its past dependence on commercial paper, many of GE’s decisions suffered due to short-term obligations. This is a fairly realistic concern for some companies, leading to a much more well-rounded investment strategy.

Despite these occasional drawbacks, commercial paper remains a great form of investment, both for the companies that benefit from its presence in their system, and the investors that gain interest as it matures. Relatively short-term and free from the risk of default, commercial paper remains a type of investment that’s both secure, scalable, relatively sustainable, and advantageous for the economy.

That said, it’s certainly not the type of investment opportunity you’d wish to jump into without an understanding of how the market functions as a whole. As with any high-volume investment – or, even a smaller initial investment – it’s always worth researching both the market, the industry, and the individual company that you’re investing in.

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