Commercial paper (CP) is a short-term money market instrument ideally suited for corporate sector borrowing from banks for their working capital needs and investments. Highly rated companies can take advantages of this source and it serves the needs of investors for parking their short-term funds, CP as a source of short-term fund is popular in the Western countries and Japan. In USA, it is in vogue for over 100 years whereas its origin in European countries and Japan is of a recent one. Commercial paper (CP) is a usance promissory note negotiable by endorsement and delivery typically with a fixed maturity between three months and six months and is issued on a discount basis. It enables companies to raise short-term debt at attractive rates of interest. CP is an unsecured instrument and is not tied to any specific business transaction. It does not carry any underlying collateral security like cash credit advance. However, since CP is carved out of the working capital limits being enjoyed by the issuing company with its bankers, it becomes a substitute source and not an additional source.
CP can be issued for a period not less than three months and not more than six months from the date of issue. Unlike the normal bills of exchange, the CP will not have any grace period of maturity. If the due date happens to fall on a holiday, the company shall be liable to make payment on the immediate preceding working day. Every issue of CP is treated as a fresh issue.
The aggregate amount to be raised by issue of CP shall not exceed twenty percent of the company’s fund based working capital limit. Moreover, CP issue is carried out of the existing fund based working capital limits being enjoyed by the company from bonded banks, hence working capital (fund based) limit will be correspondingly reduced by the bank or banks under supervision of leader of the consortium of banks.
CP are to be issued in the form of usance promissory notes, negotiable by endorsement and delivery and at such discount to face value as may be determined by the company issuing the CP. Banks are prohibited from underwriting or co-accepting the CP issue in any manner, the company issuing CP has to bear expenses on issue like dealers, fees, rating agency fees, charges levied by banks for providing stand by facilities etc. On request, banks can provide stand by facility for an amount not exceeding the amount of issue for meeting the liability of CP on maturity, if there is no roll-over of CP.
CP may be issued to any person, including individuals, banks, companies and other corporate bodies registered or incorporated or unincorporated bodies. Every company proposing to issue CP shall submit in the prescribed form an application to the banking company/the banking company designed as leader of the consortium arrangement for working capital facility together with the certificate issued by the credit rating agency.
On receipt of the application for issue of commercial paper from such company, the banking company, if on verification is satisfied that the company is eligible for issuing commercial paper, shall forward the application to the Central Bank within one week of the receipt of the application together with the certificate issued by the credit rating agency.
The Central Bank may, after considering all the application for issue of commercial paper received up to a specified date, allot to each eligible company such amount for issue of commercial paper as may be decided having regard to the conditions in the money market; which means that the Central Bank may not allow any application or allow only a part of the amount applied for if it is of the opinion that the issue of commercial paper is not conducive to the stability of the money market at the relevant time. The Central Bank will communicate the decision of allotment of the amount of commercial paper to be issued, to the banking company in writing indicating other terms and conditions, if any, to be complied with by the banking company, the leader, the issuing company, with regard to the approved issue. Every company shall on receipt of the approval to issue the commercial paper make arrangements for privately placing the issue and ensure that the issue of commercial paper, as approved, is complete within the period of two weeks from the date of the Central Bank’s approval.
The initial investor in commercial paper shall pay the discounted value of the commercial paper by means of a crossed account payee cheque to the account of the issuing company with the banking company/the leader.
The working capital (fund based) limit of every company issuing the commercial paper shall be correspondingly reduced by the banking company/leader of the consortium arrangement, once the issue is actually placed in the market and the banking company/the leader shall make necessary adjustments in the account of such company respectively with the banking company/the other member banking companies. Every company issuing commercial paper shall advise the Central Bank through the banking company/the leader, the amount of commercial paper actually issued in pursuance of the Central Bank’s approval, within three days from the date of completion of issue.
In conclusion, it may be noted that CP will be a very ideal and veritable tool for raising short-term finance for meeting occasional outflows of companies like distribution of interim and final dividends, payment of income tax, higher seasonal requirements of many industries etc. CP will contribute to the growth of money market further if the rates of return on investment in CP prove to be attractive and this instrument play a vital role in transactions in short-term funds, this will ultimately relieve pressure on the banking sector for short-term funds requirement of the corporate sector.
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