Here’s what you need to know before buying that Commercial Paper

There has been a surge in the number of corporates approaching the debt market to raise funds through commercial paper.

Just this year, corporates such as Nigerian Breweries, Flour Mills, United Capital, Sterling Bank just to mention few, have either raised or in the process of raising a CP program.

Yinka Ademuwagun consumer goods analyst at United Capital said the rush for CP is due to the lower rate environment as corporates want to take this opportunity to meet short term demands.

According to Ademuwagun, most businesses want to stay liquid in this challenging period for businesses to continue and meet some short term demands.

So what then is a commercial paper and what should investors be looking out for when buying one.

Commercial Paper is a money-market security issued by corporates to obtain funds to meet short-term debt obligations and this is usually backed only by an issuing bank or company promise to pay the face amount on the maturity date specified on the note.

Commercial Papers are usually issued for maturities between 15 days to 270 days maximum tenor, including rollover, from the date of issue.

How does it work?

For an investor in a commercial paper, you are purchasing at a discount to receive the full value at maturity.

For example, when you buy a commercial paper with a face value of N200,000 and an implied interest rate of 10%

you actually pay the company N190,000 and upon maturity, the company redeems the commercial paper by paying you N200,000.

With commercial paper, the yield is usually higher than for any of the other money market instruments because its repayment lies on the ability of the issuing company to honour the repayment obligation.

What should I look out for when buying a Commercial Paper?

Apart from the attractive yield, investors must check for the company’s fundamentals, asking question such as can this company survive the next one year? looking out for indices such as liquidity ratio, solvency ratio, credit rating from a reputable rating agency such as Agusto.

The yield a company attracts for commercial papers also depends on the credit rating of the company.

Commercial Paper is a liquid instrument with strong secondary market trading possibilities making it an attractive product for potential investors.