Commercial paper is generally rated as prime, desirable, or satisfactory, depending, or satisfactory, depending on the credit standing of the issuing company. Firms desiring to issue paper generally will seek a credit rating from one or more of three rating services- Moody's investor service, standard &Poor's corporation, and Fitch investor service. Moody‘s assigns ratings of prime-1 (p-1) for the highest-quality paper, with lower-quality issues designated as prime-2 (p-2) or prime-3 (p-3). Standard& Poor's assigns ratings of A-1, A-2, A-3, while Fitch uses F-1, F-2, F-3.
it is extremely difficult in today‘s volatile conditions to market unrated commercial paper. Indeed, paper available is mainly from top-quality issuers; about three quarters of the firms currently selling notes bearing credit ratings from at least two rating agencies are preferred by both investors and dealers.
Showing posts with label commercial paper. Show all posts
Showing posts with label commercial paper. Show all posts
Thursday, August 27, 2009
Advantage Of Issuing Commercial Paper(2)
Another advantage of borrowing in the commercial paper market is that rates there are most flexible than bank loan rates. Moreover, a company in need of funds can raise money quickly through either dealer or direct paper. Dealers maintain close contact with the market and generally know where cash may be found. Frequently, notes can be issued and funds rose the same day or within a day or two.
Generally, larger amounts of funds may be borrowed more conveniently through the paper market than from other sources, particularly bank loans. This situation arises due to federal and state regulations which limit the amount of money a bank can lend to any single borrower. For national banks, the maximum unsecured loan is 10 percent of the bank‘s capital and surplus account. frequently, corporate credit needs exceed an individual bank‘s loan limit, and a group of banks (consortium) has to be assembled to make the loan. However, this takes time and requires lengthy and complicated negotiations. Using the paper market is generally much faster than trying to hammer out a loan agreement among several parties. Moreover, the ability to issue commercial paper gives a corporation considerable leverage when negotiating with banks. A banker who knows that the customer can draw upon the commercial paper market for funds is more likely to offer advantageous terms on a loan and be more receptive to future customer credit needs..
Generally, larger amounts of funds may be borrowed more conveniently through the paper market than from other sources, particularly bank loans. This situation arises due to federal and state regulations which limit the amount of money a bank can lend to any single borrower. For national banks, the maximum unsecured loan is 10 percent of the bank‘s capital and surplus account. frequently, corporate credit needs exceed an individual bank‘s loan limit, and a group of banks (consortium) has to be assembled to make the loan. However, this takes time and requires lengthy and complicated negotiations. Using the paper market is generally much faster than trying to hammer out a loan agreement among several parties. Moreover, the ability to issue commercial paper gives a corporation considerable leverage when negotiating with banks. A banker who knows that the customer can draw upon the commercial paper market for funds is more likely to offer advantageous terms on a loan and be more receptive to future customer credit needs..
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).
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).
Wednesday, August 26, 2009
Changing yields on paper issues
Because yields on commercial paper are open-market rates, they fluctuate daily with the ebb and flow of supply and demand forces in the marketplace. In the wide swings between easy and tight money which characterized the 1970s and early 1980s, commercial paper rates fluctuated between extreme highs and lows. For example, in 1977-a year of modest economic growth and moderate credit demands- paper rates averaged only about 5.5 percent. early in 1981,however, when intense credit demands and rapid inflation characterized the economic situation, paper rates ranged upward to nearly 18 percent, or more than three times as high as in 1977. The commercial paper market is highly volatile and difficult to predict. This is why many corporations eligible to borrow there still maintain close working relationships with commercial banks and other institutional lenders.
Tuesday, August 25, 2009
Possible disadvantages of issuing commercial paper
Despite the advantages, there are some risks for corporations that choose to borrow frequently in the commercial paper market. One of these is the risk of alienating banks whose loans might be needed when a real emergency develops. The paper market is highly volatile and sensitive to financial and economic problems. This fact was demonstrated quite convincingly in 1980when Chrysler financial, the finance-company subsidiary of Chrysler Corporation, was forced to drastically cut back its borrowings in the commercial paper market due to the widely publicized troubles of its parent company. At times, it is extremely difficult even for those companies in sound financial condition to raise funds in the paper market at reasonable rates of interest. It helps to have a loyal and friendly banker available to supply emergency credit when the market turns sour. Another problem lies in the fact that commercial paper cannot be paid off at the issuer‘s discretion but generally must remain outstanding until it reaches maturity. In contrast, many bank loans permit early retirement without penalty.
Dealers in the commercial paper
The market is relatively concentrated among a handful of dealers who account for the bulk of all trading activity. the top commercial paper dealers today include Goldman Sachs&co.;A.G. Becker,Inc.; the first Boston Corporation, Lehman Brothers; and Merrill Lynch, Pierce, Fenner and Smith. Dealers maintain inventories of unsold new issues or repurchased paper but usually expect to turn over all their holdings within a week to 10 days. Like dealers in U.S. government securities, commercial-paper dealers draw upon repurchase agreements (RPs) and demand loans from banks to help finance their inventory positions. They pay interest rates which usually are only a few basis points higher than on RPs collateralized by U.S. treasury securities.
Principal investors in the commercial paper market
The most investors in the commercial paper market include non-financial corporations, money market funds, bank trust departments, smaller commercial banks, pension funds, and insurance companies. In effect, this is a market where corporations borrow from other corporations. These investor groups regard commercial paper as low-risk outlet for their surplus funds.
A recent innovation in the direct paper market is the master note, most frequently issued to bank trust department and other "permanent" money market investors. Under a master note agreement, the investing company notifies the issuing company how much paper it will purchase each day up to an agreed-upon maximum amount. Interest owed is figured on the average daily volume of paper taken on by the investor during the current month. The prevailing interest rate on six-month commercial paper generally is used to determine the appropriate rate of return.
A recent innovation in the direct paper market is the master note, most frequently issued to bank trust department and other "permanent" money market investors. Under a master note agreement, the investing company notifies the issuing company how much paper it will purchase each day up to an agreed-upon maximum amount. Interest owed is figured on the average daily volume of paper taken on by the investor during the current month. The prevailing interest rate on six-month commercial paper generally is used to determine the appropriate rate of return.
maturities of commercial paper
Maturities on commercial paper range from three days ("weekend paper) to nine months. Most commercial notes carry an original maturity of 60 days or less, with an average maturity ranging from 20 to 45 days. Commercial paper is generally not issued for longer maturities than 270 days since, under the provisions of the securities Act of 1933, any security sold in the open market for a longer term must be registered with the Securities and Exchange Commission.
Yields to the investor are calculated by the bank discount method as in the case of treasury bills. Like T-bills, most commercial paper is issued at a discount from par, and the investor‘s yield stems from the price appreciation of the security between purchase date and maturity date. However, coupon-bearing paper is also available. The minimum denomination is usually $25,000, and the notes typically are issued in bearer form. New issues generally average about $2 million each in total amount. Payment is made at maturity upon presentation to the particular bank listed as agent on the front of the note. Settlement in federal funds usually made the same day the note is presented for payment.
Yields to the investor are calculated by the bank discount method as in the case of treasury bills. Like T-bills, most commercial paper is issued at a discount from par, and the investor‘s yield stems from the price appreciation of the security between purchase date and maturity date. However, coupon-bearing paper is also available. The minimum denomination is usually $25,000, and the notes typically are issued in bearer form. New issues generally average about $2 million each in total amount. Payment is made at maturity upon presentation to the particular bank listed as agent on the front of the note. Settlement in federal funds usually made the same day the note is presented for payment.
Types of commercial paper(2)
Directly placed paper must be sold in large volume to cover the substantial costs of its distribution and marketing. On average, each direct issuer has between $600 and $700 million outstanding at any one time and will usually borrow at least $100 million per month. While issuers of direct paper do not have to pay dealer's commissions and fees, these companies must operate a marketing division to maintain constant contact with active investors. Sometimes direct issuers must sell their paper even when they have no need for funds. This is the price of maintaining a good working relationship with active investor groups. These companies also cannot escape paying fees to banks for supporting lines of credit, to rating agencies who rate their paper issues, and to agents (usually banks) who dispense required payments and collect funds.
The other major variety of commercial paper is dealer paper, issued by securities dealers on behalf of their corporate customers. Also Known as industrial paper, dealer paper is issued mainly by non-financial companies as well as by smaller bank holding companies and finance companies. The issuing company may sell the paper directly to the dealer, who buys it less discount and commission and then attempts to sell it at the highest possible price in the market. Alternatively, the issuing company may carry all the risk, with the dealer agreeing only to sell the issue at the best price available less commission (often refereed to as a best efforts basis). Finally, the open-rate method may be used, in which the borrowing company receive some money in advance but the balance depends upon how well the issue sells in the open market
The other major variety of commercial paper is dealer paper, issued by securities dealers on behalf of their corporate customers. Also Known as industrial paper, dealer paper is issued mainly by non-financial companies as well as by smaller bank holding companies and finance companies. The issuing company may sell the paper directly to the dealer, who buys it less discount and commission and then attempts to sell it at the highest possible price in the market. Alternatively, the issuing company may carry all the risk, with the dealer agreeing only to sell the issue at the best price available less commission (often refereed to as a best efforts basis). Finally, the open-rate method may be used, in which the borrowing company receive some money in advance but the balance depends upon how well the issue sells in the open market
Types of commercial paper(1)
There are two major types of commercial paper-direct paper and dealer paper.
The main issuers of direct paper are large finance companies and bank holding companies, who deal directly with the investor rather tan using a securities dealer as an intermediary. These companies, which regularly extend installment credit to consumer and large working-capital loans and leases to businesses firm, announce the rates they are currently paying for various maturities. Investors then select those maturities which most closely approximate their expected holding periods and buy the securities directly from issuer.
Leading finance-company borrowers in the direct paper market include General Motors Acceptance Corporation, CIT Financial Corporation, commercial credit corporation, and general electric credit corporation. The lending bank holding companies which issue commercial paper are centered around the largest banks in New York, Chicago, San Francisco, and other major U.S. Cities. Today, about 80 financially oriented U.S. companies' account for nearly all the directly placed paper, with finance companies issuing approximately three fourths of the total. All of these firms have an ongoing need for huge amounts of short-term money; posses top credit ratings, and have established working relationship with major institutional investors in order to rapidly place their new note issues.
The main issuers of direct paper are large finance companies and bank holding companies, who deal directly with the investor rather tan using a securities dealer as an intermediary. These companies, which regularly extend installment credit to consumer and large working-capital loans and leases to businesses firm, announce the rates they are currently paying for various maturities. Investors then select those maturities which most closely approximate their expected holding periods and buy the securities directly from issuer.
Leading finance-company borrowers in the direct paper market include General Motors Acceptance Corporation, CIT Financial Corporation, commercial credit corporation, and general electric credit corporation. The lending bank holding companies which issue commercial paper are centered around the largest banks in New York, Chicago, San Francisco, and other major U.S. Cities. Today, about 80 financially oriented U.S. companies' account for nearly all the directly placed paper, with finance companies issuing approximately three fourths of the total. All of these firms have an ongoing need for huge amounts of short-term money; posses top credit ratings, and have established working relationship with major institutional investors in order to rapidly place their new note issues.
Saturday, May 9, 2009
commercial paper
commercial paper is a from of direct short-term finance by large,creditworthy company such as A&t needs immediate funds,it can sell commercial paper(a debt instrument)to another corporation or financial institution. Commercial paper is a promise to pay back a higher specified amount at a designated time in the immediate future---say,30days. By issuing commercial paper,a corporation avoids the process of applying for a loan and instead engages in direct finance. To engage in direct finance effectively,the issuing company must be large and creditworthy enough to find someone willing to accept its commercial paper,which is sold with the aid of brokers.the use of commercial paper grew from $50 billion in 1976 to $339 billion in 1992,an increase of about 12.7 percent per year. The growing use of commercial paper has increased the competitive pressure on banks,which are finding some of their potential loan customers turning to the commercial paper market.
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