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What is a commercial paper? What are its advantages and limitations?

Answer:

Ans.     Commercial Paper:

1. Commercial paper is an unsecured, short-term debt instrument issued by a corporation, typically for the financing of accounts receivable, inventories and meeting short-term liabilities.

2. Maturities on commercial paper can range up to 365 days. The debt is usually issued at a discount, reflecting prevailing market interest rates.

3. Commercial paper is not usually backed by any form of collateral, so only firms with high-quality debt ratings will easily find buyers without having to offer a substantial discount (higher cost) for the debt issue.

Advantages and Limitations of Commercial Paper Advantages:

1. For the most part, commercial paper is a very safe investment because the financial situation of a company can easily be predicted over a few months.

2. Typically only companies with high credit ratings and credit worthiness issue commercial paper. Hence the companies issuing them enjoy (a) the prestige associated with such issuance and (b) the ability to issue large quantum without much hassles like other types of financing which requires restrictions from regulatory bodies.

3. Interest rate is generally lower compared to others like bank loans and other types of short term financing

Disadvantage:

1. It does not have any flexibility with regard to repayments.