Commercial paper (CP) ha its origin in the financial markets of America and Europe . The concept of CPs was originated in USA in early 19th centaury when commercial banks monopolized and charged high rate of interest on loans and advances .
Further in India commercial paper introduced in January 1990 on the recommendation of Vaghul Committee subject to various conditions. When the process of financial dis-intermediation started in India in 1990, RBI allowed issue of two instruments, viz., the Commercial Paper (CP) and the Certificate of Deposit (CD) as a part of reform in the financial sector.
Moreover, notable feature of RBI Credit Policy announced on 16.10.1993 was the liberalisation of terms of issue of CP. Besides, at present it provides cheap source of funds for corporate sector and has caught the fancy of corporate sector and banks.
Commercial paper are unsecured and negotiable promissory notes issued by high rated corporate entities to raise short term funds for meeting working capital requirements directly from the market instead of borrowing from banks.
However, CPs period ranges from 7 days to 1 year. CP is issued at discount to face value the issue of commercial paper seeks to pass the intermediately role of the banking system through the process of securitization.
Further, Cps partly replaces the working capital limits enjoyed by companies with the commercial banks. And there will be no net increase in their borrowing by issue of CP. Generally, CP has to be issued at a discount to face value. Further, yield on CP is freely determined by the market.
The yield CP can be calculated as follows :
Y= FV-SV/SVX Days or months in a year/M X100
Where,
Y= Yield
FV = Face value
SV= Salve value
M= Period of discount
Example of commercial paper
ABC Co. Ltd. issued commercial paper worth Rs. 10 crores as per following details :
Date of issue : 16th January, 2019
Date of maturity : 17th April, 2019
No. of days : 91 days
Lastly, interest rate : 12.04% p.a.
What was the net amount received by the company on issue of CPs? (Charges of intermediary may be ignored).
Solution:
The company had issued commercial paper worth Rs. 10 crores.
No. of days involves = 91 days
Further, interest rate applicable = 12.04% p.a.
Interest for 91 days = 12.04%X91 days/365 days = 3.002%
= or Rs. 10 crores X 3.002/100+3.002 = Rs. 29,14, 507
=or, 29.14507 Lakhs
Therefore, amount received at the time of issue = Rs 10 crores – Rs. 0.29151 crores = Rs. 9.70849 crores.
Refer: https://taxandfinanceguide.com/money-market-instruments/
