Commercial Paper

Large, well-known companies often issue their own short-term unsecured debt notes rather than borrow directly from banks. These notes are called commercial paper. Very often, commercial paper is backed by a bank line of credit, which gives the borrower access to cash that can be used (if needed) to pay off the paper at maturity.

Commercial paper maturities range up to 270 days; longer maturities would require registration with the Securities and Exchange Commission and so are almost never issued. Most often, commercial paper is issued with maturities of less than one or two months. Usually, it is issued in multiples of $100,000. Therefore, small investors can invest in commercial paper only indirectly, via money market mutual funds.

Commercial paper is considered to be a fairly safe asset, because a firm's condition presumably can be monitored and predicted over a term as short as one month. Many firms issue commercial paper intending to roll it over at maturity, that is, issue new paper to obtain the funds necessary to retire the old paper. If lenders become complacent about a firm's prospects and grant rollovers heedlessly, they can suffer big losses. When Penn Central defaulted in 1970, it had $82 million of commercial paper outstanding. However, the Penn Central episode was the only major default on commercial paper in the past 40 years. Largely because of the Penn Central default, almost all commercial paper today is rated for credit quality by one or more of the following rating agencies: Moody's Investor Services, Standard & Poor's Corporation, Fitch Investor Service, and/or Duff and Phelps.

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