Understanding Commercial Papers

Understanding Commercial Papers

In the world today, a lot of fixed-income securities are being traded in the Capital / Money market. The major disparity between both is the tenor of the securities traded in them. While Money market is used for short-term lending or borrowing with a maturity of usually 270 days or less, long-term securities of more than 270 days are created and traded in the capital market. Therefore, money market securities are usually less risky because they are less volatile due to their short-term nature.

Commercial Paper (CP) falls into one of such categories of fixed-income securities sold in the money market and is a common feature in many money market mutual funds. A CP is an unsecured debt obligation issued by large organisations and financial institutions as a better alternative to costly methods of funding, and also to meet short-term financial obligations. 

The history of Commercial Paper dates back to over a 100 years. Back then, New York merchants sold their short-term obligations to dealers for the purpose of gaining access to capital to cover their near-term obligations. 

These dealers acted as middlemen between the merchants and the banks/investors. After purchasing the Notes at a discount from their par value, they would transfer them to banks or other investors. The borrower would then repay the investor an amount equal to the par value of the Note.

CPs were introduced in Nigeria in 1962 to finance the export-marketing operations of the then Northern Marketing Board. Under that arrangement, the marketing boards met their cash requirements by drawing ninety-days (90 days) Bills of Exchange on the marketing boards.

Over the years, Commercial Papers have grown to be the most common form of short-term debt instruments issued by Corporates in Nigeria. The statistics from the FMDQ show that CPs issued in the first half of the year 2022 equaled N249 Billion. This is about a 7% improvement compared to that issued in the same period of 2021.  

As a more convenient method of financing, CPs are usually issued at a discount from face value and reflect prevailing market interest rates. Just like other types of Bonds or debt instruments, the Issuer is of the assumption that it will have the capacity to pay both interest and principal at maturity.

Most Credit Rating Agencies rate Commercial Papers on a similar basis to Corporate Bonds. Lower Ratings are assigned to CPs with weak or poor abilities to meet their current obligations and financial strength vulnerable to adverse changes in economic conditions.


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