Every time a company needs money to fund its daily operations, there’s an opportunity for your mutual fund and a few other sets of investors to make money out of it. To generate capital, companies issue short-term debt instruments called commercial papers (CPs) into which your fund house or other investors can put money.
What are they?
These are unsecured money-market instruments and are issued in the form of a promissory note. Like any other debt instrument, they come with a fixed tenor. In simple words, they mature after a specific period of time.
CPs are issued at a discount to face value as determined by the issuer. For instance, if the face value of a particular CP with a maturity tenor of one year is Rs 1,000 and the coupon rate is 10%, the price (discounted) you need to pay at the time of investment would be Rs 909.09 but on redemption you would get Rs 1,000.
Why do companies issue them?
In a high interest rate regime, companies need to shell out more to borrow money from banks. As interest rates are high, even a reputed company would be able to borrow funds at an interest rate of 13-14% per annum. Such high interest rates increase the overall cost of the company, which in turn reduces their competitiveness.
Hence, to keep the overall cost in check, companies resort to issuing CPs. If a company manages to raise funds through CPs at say 11-12%, the interest burden (interest that it has to pay to its creditors or people from whom it borrows the money) would get reduced substantially, which also helps in lowering the overall cost.
Typically, companies offer slightly higher rates of say 50-100 basis points than those prevailing on certificates of deposit, or CDs, (banks issue them) of similar tenor to attract buyers. This is to attract investors to prefer CPs over CDs.
Also, companies with better rating offer less interest rate than those with poorer ratings. This is because companies with lower credit ratings need to pay a premium to potential investors to compensate for their low credit rating.
Who can invest?
Individuals, non-resident Indians, banks, companies and foreign institutional investors (FII) can invest in CPs. They are available either in physical or dematerialized form.
You need at least Rs 5 lakh to invest in them. Of course if you are a retail investor, a high entry barrier may dissuade you from investing in it. However, FII investments are subject to the limit set by the Securities and Exchange Board of India. Retail investors can subscribe to CPs either in physical form or in dematerialized form. However, banks, MFs, financial institutions and primary dealers can hold CP only in dematerialized form.
CPs are unsecured money market instruments and as such are not covered or backed by any asset. If a CP were to default, investors would have to take normal legal recourse, which can be a long haul.
Also, since CPs are not popular at the retail level, it is not easily available with retail brokers. It is, therefore, difficult for individual retail investors to locate CPs. The high investment limit is another deterrent.