Commercial Paper

Commercial paper is typically used by companies as a source of working capital, receivables financing, and other short-term financing needs. To build major items such as an $800 million factory, a company generally issues long-term bonds (funded debt), and pays the lenders back slowly.

But if Microsoft needs a mere $50 million for a few months, they would probably prefer to borrow it short-term at the lowest possible interest rate.

If so, they issue commercial paper with a $50 million face amount, selling it to a money market mutual fund for, say, $49.8 million. Again, the difference between the discounted price and the face amount represents the interest earned by the investor.

Commercial paper is generally issued only by corporations with high credit ratings from S&P, Moody's, or Fitch.

Commercial paper could be described as an unsecured promissory note, as opposed to the BA we just examined, which provides collateral to the lender. Some large corporations issue their commercial paper directly to investors, which may be mutual funds, pension funds, etc.

The industry calls this "directly placed commercial paper." When corporations use commercial paper dealers to sell to the investor, the industry refers to this as "dealer-placed commercial paper."