Thursday, August 27, 2009

Advantage Of Issuing Commercial Paper(1)

The several financial advantages to a company able to tap the commercial paper market for funds. Generally, rates on paper are lower than on corporate loans extended by commercial bank. For example, the bank prime rate was consistently at least a full percentage point and sometimes more than two percentage points higher than the rate on six-month dealer paper. This spread between the bank prime rate and the six-month paper rate widened to three or four percentage points in both 1980 and 1981.
Moreover, the effective rate on most commercial loans granted by banks is even higher than the quoted prime rate, due to the fact that corporate borrowers usually are required to keep a percentage of their loans in a bank deposit. This so-called compensating balance requirement is generally 15 to 20 percent of the amounts of the loan. Suppose a corporation borrower $100,000 at a prime interest rate of 15 percent but must keep 20 percent of this amount on deposit with the bank granting the loan. Then the effective loan rate is 18.75 percent (or $15,000\$80,000).

No comments: