The Weekly Report: Commercial Paper Unplugged

25 June 2012

Have you ever seen a Vh1 “Unplugged” performance? It features an artist on a muted stage in stripped-down glory, with an acoustic guitar and/or piano to accompany a bare voice. When you take away all the usual trappings, distractions and hype, “Unplugged” performances show that class is class. In this spirit of purism, this week we briefly deconstruct commercial paper along with its relevant benefits and drawbacks.

Deposits, bonds and repurchase agreements – sounds like your typical investment diet, right? While these are no doubt familiar to most institutions throughout the region, perhaps a change of tack is needed in response to the considerable headwinds we all face at this time. Commercial paper may sound “too sexy for your shirt” in comparison to the more ‘vanilla’ investment products available, but in the grand scheme of things it ranks fairly low in terms of sophistication and its sexiness therefore, really shouldn’t hurt, no matter what Right Said Fred sings (unplugged or not).

A Commercial Paper Definition

An unsecured short term debt instrument issued by a corporation typically for the financing of accounts receivable, inventories and meeting short term liabilities. Commercial Paper is sold at a discount and maturities rarely range any longer than 270 days.

TTSE Glossary

Despite this definition, in practice, commercial paper can in fact be secured and may go up to one year in terms of maturity. Now down to the important part: what’s in it for you?

The attractiveness primarily lays in the above-average risk adjusted returns as it can allow for participation in investment grade backed credits at relatively high yields.

In India this feature has been observed and the country’s largest insurer, LIC “has decided to step up its investment in commercial papers to provide liquidity to corporate and finance companies struggling with tight liquidity. The insurer will buy Rs 5,000 crore worth of paper as opposed to Rs 3,000 earlier, hoping also to benefit from higher rates.” (The Economic Times)

It goes on to say that “insurance companies are generally long-term investors but given the current high interest rates, corporate houses and companies are securing short-term capital requirements through CPs. The maximum tenure for a CP is one year. LIC is looking to get the best out of its investments.”

As with all investments, you MUST consider the attached risks. Return comes at a price! Just take a look at the (hopefully familiar) graph below.

Australian Bankers Association Inc.

When deciding where to invest short-term, you have to strike a balance between liquidity, safety, convenience and yield. Chasing yield in the commercial paper market or corporate short-term bonds may give you a pick-up in yield over a short-term CD. But that increase in yield is, in part, compensating you for the additional risk you’re taking on in the investment. You have to decide if you’re being adequately compensated for that risk.

While this is just a primer to the world of commercial paper, it is hoped that the information provided is just enough to whet your investment appetite. We look forward to your questions, and we may just have investment grade-backed commercial paper to offer you!

Gerard Stephens
Account Executive Sales

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