COMMERCIAL PAPER

A form of financing consisting of short-term, unsecured promissory notes

issued by firms with a high credit standing.
Typically used for the financing of accounts receivable, inventories and
meeting short-term liabilities.
Most commercial paper issues have maturities ranging from 3 to 270 days.
Generally issued in multiples of $100,000 or more.
Major benefit: it does not need to be registered with SEC as long as it matures
before 270 days.

INTEREST ON COMMERCIAL PAPER

Commercial paper is sold at a discount from its par or face value.

The size of the discount and the length of time to maturity determine the
interest paid by the issuer of commercial paper.
The interest cost is normally 2% to 4% below the prime rate but the overall
cost of commercial paper may not be less than that of a bank loan.

Formula:

i=

FACE VALUE AMOUNT PAID

AMOUNT PAID

i
1+

Effective Annual Rate=

Where:
i= interest rate
n= maturity period

ibey
EAR 1

365 / h

365/ h

Example:
Bertram Corporation, a large shipbuilder, has just issued $1 million worth of
commercial paper that has a 90-day maturity and sells for $990,000. At the end of
90 days, the purchaser of this paper will receive $1 million for its $990,000
investment. The interest paid on the financing is therefore $10,000 on a principal of
$990,000. The effective 90-day rate on the paper is 1.01% ($10,000/$990,000).
Assuming that the paper is rolled over each 90-days throughout the year (that is
365/90 = 4.06 times per year), the effective annual rate for Bertrams commercial
paper is 4.16% [(1+0.0101)4.06-1].