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Michigan CLASS

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Understanding Commercial Paper

The commercial paper (CP) market has evolved over time, originating as a short-term funding mechanism for large, non-financial corporations and has since developed into a systematically important financing segment of the global economy. CP has provided a way for issuers to efficiently manage current account cash flows such as operating expenses, inventories, and receivables, and the global economy as a whole has benefitted from the maturation of the CP market. From ensuring employees are paid in a timely manner to supporting international trade, CP financing provides a valuable source of funding that keeps costs down and aids the economy in reaching its full potential.

What is Commercial Paper?

Commercial paper can be a low-cost alternative to a traditional bank credit line. In many cases, it is cheaper for corporations to rely on CP as opposed to accessing and drawing on their bank’s line of credit, allowing established corporations with high credit ratings a cheaper funding source. Either way, CP can enter the marketplace through a broker while direct CP issuers, often financial or banking companies, are able to access the market without using an intermediary.

Put simply, CP is akin to a credit card designed for large, financially stable companies. Sometimes, these companies have cash needs and sometimes they do not. Going to the CP marketplace provides an efficient way to borrow money on a short-term basis with the understanding that it will be repaid with interest in the future.

Why Does Commercial Paper Matter?

Commercial paper makes a difference to the corporations that fund their flow of goods and services and payrolls on a weekly, monthly, and/or quarterly basis. It also benefits short-term investors by providing a safe, liquid alternative with enhanced returns. When you add up the benefits, CP is clearly good for the economy as it facilitates growth by bridging short-term capital needs.

While the CP market ebbs and flows, it can often be strained by market volatility, money fund activity, or traditional investor appetites for product. Over time and in the wake of the financial crisis, the volume of outstanding CP has steadily fallen and is often refinanced daily, adding to the burden of those intermediaries that play the vital role in facilitating our free market economy.

Like any investment, there are risks; but when CP is properly utilized and evaluated, a sound credit process, like the one at Michigan CLASS, can eliminate much of the risk. For more on commercial paper, including an introduction to asset-backed commercial paper, and our thoughts on the vital role it plays in the economy, please click here to download the Public Trust Advisors, LLC white paper, “Commercial Paper Demystified.”

The information presented should not be used in making any investment decisions and is not a recommendation to buy, sell, implement, or change any securities or investment strategy, function, or process.  Any financial and/or investment decision should be made only after considerable research, consideration, and involvement with an experienced professional engaged for the specific purpose.  All comments and discussion presented are purely based on opinion and assumptions, not fact. These assumptions may or may not be correct based on foreseen and unforeseen events.