What is Commercial Paper?

COMMERCIAL PAPER (CP) : Commercial paper (CP) is a money market security. It is a
short term unsecured promissory note issued by a firm for the loan taken. Such
commercial papers are issued by reputed companies for meeting their urgent short term
needs. The features of commercial paper are as follows:
(a) The usual period for the issue of commercial paper is 180 days.
(b) It is sold at a discount and is redeemable at its face value.
(c) The denomination of commercial paper is normally high and is bought by institutional
investors and companies for short term investment of surplus funds available with
them. Commercial paper is not popular with the individual investors as they do not
have capacity to purchase it due to high denomination. Moreover, the return on the
investment is also not attractive.
The Commercial Papers were introduced in India as per framework suggested by
the Working Group on Money Market in 1987. The RBI announced its decision to introduce
a scheme under which certain companies could issue CPs in the Indian Money Market.
The RBI issued guidelines to issue CPs which came into effect from 1st January, 1990.
The objective was to enable highly rated companies to diversify their sources of short term
borrowings. It is an additional instrument for the investors in the market. The guidelines
issued by the RBI were applicable to all non-banking financial and non-financial
companies who intend to raise funds through issuing CPs. The companies governed by
the Foreign Exchange Regulation Act, 1973 have been granted general permission by the
RBI to issue commercial papers. Any private or public sector company could issue CPs
provided that it satisfies the conditions laid down by the RBI.
Any person, bank, company incorporated or unincorporated body could invest in
CPs. Non-Resident Indians were also allowed to invest in CPs but only on non-repatriable
and non-transferable basis and this must be indicated on CPs issued to them. The
maturity period of CP was initially from 3 months to 6 months. The minimum size of a CP
was ` 25 lakhs and CPs were to be issued in the multiples of 25 lakhs subject to the
minimum size of an issue being ` 1 crore. Similarly, the minimum amount to be invested
by a single investor in the primary market was ` 1 crore of the face value. The CP could be
issued on a single date or in parts on different dates within a period of two weeks from the
date of the approval of issue by the RBI. These conditions were modified by the RBI later
on. CPs are to be issued at a discount to their face value and the discount rate is to be
freely determined in the market. The timings and amount of issue of CPs need the
approval of RBI. CPs are freely transferable and negotiable. Banks are not permitted to
either undertake or to co-accept the issues of CPs. A company issuing CPs may seek the
standby facility from its banker for an amount not exceeding the amount of the issue for
meeting the liability of the CPs on maturity. The issuing company is required to meet the
stamp duty, dealer’s fees, rating agency fees, the standby facility charges and all other
expenses required for issuing CPs. The maximum amount of CP finance that a company is
allowed to raise is limited to 20 per cent of the maximum permissible bank finance. The
working capital fund-based limit of the issuing company from banks is to be reduced to the
extent of the amount of CPs when they are actually issued.