Commercial paper is one of the most popular money market instruments. CP (Commercial paper) is a low-risk short-term debt instrument. Many fixed income schemes of mutual funds invest in commercial papers. As per the latest news and guideline from SEBI, commercial papers can be now listed on stock exchanges. This will surely increase the participation of individual investors in CP. Here is complete information about CP including key features and guidelines of investing.
What are Commercial papers?
Commercial Paper (CP) is an unsecured money market instrument issued in the form of a promissory note. This instrument was issued in 1990. Any institution looking to raise funds for a short-term requirement can make use of commercial papers. It is an unsecured debt instrument that is issued for the period from 7 days to one year. CP can be issued in denomination of 5 Lakh or multiples thereof.
Let’s try to understand CP in simple language. Suppose company X needs cash for the short term says for one year. This may be due to a new project, product development, expansion etc. Company X can reach to an investor planning to invest money. The company X ask for loan and promise to give a certain percentage of return. The return percentage is 7 to 9%. The company X issues paper which contains a promise to pay a return on behalf of money. This paper is known as commercial paper. This type of paper is unsecured and risky.
The risk level depends on the reputation and financial status of the company. Suppose you are investing in commercial paper issued by DHFL it will be risky. On the other hand, if you are investing in a paper issued by a big reputed company like L&T it will be safe.
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Advantages of CP
- Commercial paper is a good investment bet to diversify your portfolio.
- It is a quick and cost-effective way of raising working capital.
- It is the best way to the company to take advantage of short term interest fluctuations in the market.
- CP’s are cheaper than a bank loan.
- It has a wide range of maturity.
- It is unsecured and thus does not create any liens on assets of the company.
Who can issue Commercial Papers?
As per RBI rule, Corporates, primary dealers and all financial institutions are eligible to issue CP for meeting short term requirements. All corporate cannot raise CP. The condition set by RBI
- The tangible net worth of the company, as per the latest audited balance sheet, is not less than Rs. 4 crore
- Company has been sanctioned working capital limit by bank/s or all-India financial institution.
- The borrowal account of the company is classified as a Standard Asset by the financing bank/s/ institution/s.
All eligible company needs to get credit rating for issuance of CP. The rating can be obtained from CRISIL, ICRA, CARE or FITCH. The minimum credit rating required is A-2.
Key Features of Commercial Paper
- The maturity period is in between 7 days to 1 year.
- The credit rating of the issuer should be valid up to the maturity period.
- CP can be issued in denomination of 5 Lakh and multiple of it thereof.
- It is short term Investment Avenue with higher liquidity.
- It is an unsecured instrument and not backed by any assets of the company.
- This instrument can be sold directly to the issuing company or to other investor in the market.
Who can invest in Commercial paper?
Individuals, banking companies, other corporate bodies (registered or incorporated in India) and unincorporated bodies, Non-Resident Indians (NRIs) and Foreign Institutional Investors (FIIs) etc. can invest in CPs. However, investment by FIIs would be within the limits set for them by Securities and Exchange Board of India (SEBI) from time-to-time.
Should you invest in commercial papers?
Commercial paper is an investment bet to diversify your portfolio. However, as it is an unsecured instrument you should check the rating of the company before investing. Opt for Blue Chip Company or reputed company before investing.
This investment instrument is not for the conservative investor. If you are a conservative investor you should stay away from this instrument. You can opt for a traditional investment option such as a fixed deposit. If you are a risk-taker investor you can opt for commercial paper.
As per me, instead of investing in CP you should invest in high-quality ultra-short term debt funds. These funds invest a portion of money in safe commercial papers and offer returns in the range of 7-9% without any lock-in period.