Meaning of Commercial Paper
Commercial paper is an unsecured promissory note issued by a firm to raise funds for a short period, varying from 90 days to 364 days. It is issued by one firm to other business firms, insurance companies, pension funds and banks. The amount raised by CP is generally very large. The firms having good credit rating can only issue the CP. Reserve Bank of India (RBI) regulates CP.
Merits of Commercial Paper (CP)
1. No restrictive conditions:
A commercial paper is sold on an unsecured basis and does not contain any restrictive conditions.
2. Highly liquid:
As it is a freely transferable instrument, it has high liquidity.
3. Economical:
Generally, the cost of CP to the issuing firm is lower than the cost of commercial bank loans.
4. Continuous and convenient source:
A commercial paper provides a continuous source of funds as their maturity can be adjusted to suit the requirements of the issuing firm and maturing commercial paper can be repaid by selling new commercial paper.
5. Use of surplus funds:
Companies can invest their excess funds in commercial paper and earn some good return on the same.
Limitations of Commercial Paper (CP)
1. Not suitable for all companies:
Only financially sound and highly rated firms can raise money through commercial papers. New and moderately rated firms are not in a position use this source.
2. Limited amount:
The size of money that can be raised through commercial paper is limited to the excess liquidity available with the suppliers of funds at a particular time.
3. Impersonal method:
Commercial paper being an impersonal method of financing, if a firm is not in a position to redeem its paper due to financial difficulties, extending the maturity of a CP is not possible.