CP:s and bonds
This paper analyses two markets where companies raise funds.
Commercial papers (CP) are unsecured, wholesale promissory notes with fixed maturities for up to one year, usually issued at a discount to par value and repay full par at maturity. The interest earned is thus implied in the difference between the amount the company receives and the higher it repays. CP:s are largely used to finance accounts receivables and are essential in keeping many businesses afloat.
The bond market is another environment where debts are issued and taken up by investors. As a capital market it is concerned with loans with long-term maturities (5-30 years) and companies use them to invest in new facilities etc. thus increasing growth opportunities. Bonds long-term maturity makes an active secondary market essential. Most bonds pay a rate of interest (usually semiannually) known as a coupon but zero-coupon bonds (which do not pay interest but, like most commercial papers, are sold at a discount to par) also exists.
Bonds and CP:s are generally issued by companies with high credit rating. However, companies with lower credit ratings can back their CP with a letter of credit (in return for a fee, a bank guarantee the paper should the company default). They are thus considered low-risk, despite being unsecured. Furthermore are creditors (bond and CP holders) the first to receive their money back in the case of a crisis and companies are obligated to repay them even in they make a loss. Issuing lots of debts can thus create, or increase, a loss and harm the company.
However, both markets are useful sources for companies to raise funds and many use a combination of the two. Compared with bank loans, they are generally cheaper and offer more flexibility.
Both markets are examples of disintermediation (a financial institution brings the surplus and deficit sectors together without acting as a principal). This limits banks exposure to risk since they do not make the loan
Commercial papers (CP) are unsecured, wholesale promissory notes with fixed maturities for up to one year, usually issued at a discount to par value and repay full par at maturity. The interest earned is thus implied in the difference between the amount the company receives and the higher it repays. CP:s are largely used to finance accounts receivables and are essential in keeping many businesses afloat.
The bond market is another environment where debts are issued and taken up by investors. As a capital market it is concerned with loans with long-term maturities (5-30 years) and companies use them to invest in new facilities etc. thus increasing growth opportunities. Bonds long-term maturity makes an active secondary market essential. Most bonds pay a rate of interest (usually semiannually) known as a coupon but zero-coupon bonds (which do not pay interest but, like most commercial papers, are sold at a discount to par) also exists.
Bonds and CP:s are generally issued by companies with high credit rating. However, companies with lower credit ratings can back their CP with a letter of credit (in return for a fee, a bank guarantee the paper should the company default). They are thus considered low-risk, despite being unsecured. Furthermore are creditors (bond and CP holders) the first to receive their money back in the case of a crisis and companies are obligated to repay them even in they make a loss. Issuing lots of debts can thus create, or increase, a loss and harm the company.
However, both markets are useful sources for companies to raise funds and many use a combination of the two. Compared with bank loans, they are generally cheaper and offer more flexibility.
Both markets are examples of disintermediation (a financial institution brings the surplus and deficit sectors together without acting as a principal). This limits banks exposure to risk since they do not make the loan