Commercial Paper 2003 Ranjita

Commercial papers

By Ranjita Mohapatra

MEANING
It is an unsecured promissory note issued with a fixed maturity by a company approved by RBI, negotiable by endorsement and delivery, issued in bearer from and issued at such discount on the face value as may be determined by the issuing company. It is the debt instruments issued by corporate houses for raising short-term financial resources from the money market. An unsecured obligation issued by a corporation or bank to finance its short-term credit needs, such as accounts receivable and inventory. Maturities typically range from 2 to 270 days. Commercial paper is available in a wide range of denominations, can be either discounted or interest-bearing, and usually have a limited or nonexistent secondary market. Commercial paper is usually issued by companies with high credit ratings, meaning that the investment is almost always relatively low risk.

Features
A short term money market instrument comprising promissory note with a fixed maturity. A certificate evidencing an unsecured corporate debt or short term maturity. Issued at a discount to face value basis but it can also be issued in interest bearing form. The issuer promises to pay the buyer some fixed amount on some future period but pledges no assets. It can be issued directly by a company to investors or through banks/merchant bankers.

Market for CPs: The market for CPs comprises of issues made by public sector & private sector enterprises.  CPs issued by top rated corporate are considered as sound investments.  Beginning from September 1996, Primary Dealers(PDs) were also permitted by RBI to issue CPs for augmenting their resources. Rating:A rated CP is considered to be a quality & sound instrument. With the liberalization of interest rate structure the rate of interest is market-determined. Interest rates:The rate of interest applicable to CPs varies greatly. This variation is influenced by a large no. of factors, such as credit rating of instrument, economic phase, the prevailing rate of interest in CPs market etc.

Advantages 
Simplicity  Flexibility  Diversification  Easy to raise long term capital  High returns Movement of funds

Commercial paper in India o It is an instrument of money market.
o On the recommendations of the Vaghul Working Group, the RBI announced on 27th March, 1989 that commercial paper will be introduced in Indian money market. Recommendations on commercial paper in Indian market are: Need to have a limited introduction. Careful planning. Initial access to the commercial paper market is restricted to rated companies having a net worth of Rs.5 crores and above with good dividend payment record. Commercial market should function within the overall discipline of CAS. The size of single issue should not be less than Rs.1 crore & the size of each lot should not be less than Rs.5 lacs. It would not be tied to any specific transaction & the maturity period may be 7 days and above, but not exceeding 6 months.

Issuing company should have; a. Net worth Of not less than Rs.5 crores b. Debt equity ratio of not more than 1.5 c. Current ratio of more than 1.33 d. Debt servicing ratio closer to 2 e. It should be listed on stock exchange It should not be subject to stamp duty at the time of issue as well as at the time of transfer by endorsement & delivery. The paper could be issued at a discount to face value or could be interest bearing. Detailed guide lines were issued in December 1989, through nonbanking companies direction,1989. Finally it was introduced in India from 1st Jan,1990.

RBI Guidelines on Commercial Paper Issue
Commercial paper must have; ‡ A tangible net worth of not less than Rs.10 crores as per latest balance sheet. ‡ Minimum current ratio of 1.33:1 ‡ A fund based working capital limit of Rs. 25 crores or more. ‡ Debt servicing ratio closer to 2. ‡ The company should listed on a stock exchange. ‡ Subject to CAS discipline. ‡ Classified under Health Code No.1 by the financing banks. It should be issued in multiples of Rs. 25 lacs , but the minimum amt to be invested shall be Rs. 1 crore. Maturity period must be 7 days to 6 months. No grace period on maturity. Aggregate amt shall not exceed 20% of issuer¶s fund based working capital. It is issued in the form of promissory notes, negotiable by endorsement & delivery. Issue of commercial paper can¶t be underwritten in any manner.

Investment in it can be made by any person or banks or corporate bodies registered in India. Non-resident Indians can invest in commercial paper on nonrepatriation basis. It would be required to ensure that the relevant provisions of the various statutes i.e. Companies Act, 1956, The IT Act, 1961 & Negotiable Instruments Act, 1981 are complied with.

Procedure & time frame for issue of commercial paper
1. Application to RBI through financing bank for working capital facilities together with a certificate from credit rating agency 2. RBI should communicate their decision in written. 3. Issue should be completed within 2 weeks from the date of approval of RBI through private placement. 4. Issue may be spread over 2 weeks on different dates but all such commercial paper should bear the same maturity date.

Implications of commercial paper
It brings a large no. of borrowers as well as investors in touch with each other, without the intervention of the banking system. The borrowers can get at least 20% of their working capital requirements directly from market at rates which may be more advantageous than borrowing from a bank. A. Implications on bank: Impact on bank may be of two dimensions,  The bank themselves can invest in CPs & show this as a short term investment.  The banks are likely to lose interest on working capital loan which has been hitherto lent to the companies, which have, now started borrowing through CPs. B. Impact on economy: With the introduction of CP, financial disintermediation has been gaining momentum in the Indian Economy. If CPs are allowed to free play, large companies as well as banks would learn to operate in a competitive atmosphere with more efficiency.

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