02-1619 Commercial Paper.Qxd

COMMERCIAL PAPER— A SHORT-TERM INVESTMENT ALTERNATIVE

Fixed Income: Commercial Paper

Commercial paper is short-term promissory notes issued by corporations and finance companies to raise funds for current expenses, working capital and other corporate purposes. When investors buy commercial paper, they are lending money to the issuing corporation. In return for this loan, the issuer agrees to pay interest and return principal when the note matures at a specified date in the future. Commercial paper typically mature in less than 270 days and is sold in minimum amounts of $100,000 or $250,000.

Generally, commercial paper is unsecured, but in a small number of cases, it may be secured by assets of the company. Typically, companies issuing commercial paper have revolving lines of credit from financial institutions. While these lines of credit are generally not guarantees of the paper, there is an on-going requirement that the company maintain sufficient available amounts under the lines of credit to cover all outstanding commercial paper.

Commercial paper is typically issued at a discount to par or face value. The difference between the face value of the commercial paper note at maturity and the discount is the interest earned by the investor. Generally, investors hold commercial paper to maturity, but it can be resold. The resale market is limited primarily to the dealer originally selling the commercial paper; however, there is no guarantee that the dealer will be willing to repurchase the commercial paper from the investor.

WHO INVESTS IN COMMERCIAL PAPER BENEFITS OF INVESTING IN COMMERCIAL PAPER Commercial paper is generally purchased by investors Yield: The yield on commercial paper generally tracks that seeking a short-term liquid security. The large number of of other money market alternatives. Yields on commercial issuers, short-term maturity and low credit risk make paper are higher than those offered on comparable U.S. commercial paper an attractive investment alternative for Treasury Bills due to the higher credit risk of commercial short-term portfolio managers and for the liquid portion of paper. In addition, commercial paper yields are higher due longer-term portfolios. Commercial paper is also used by to U.S. Treasury state tax exemption and greater liquidity individual investors who need short-term liquidity of Treasury Bills. combined with a specific maturity under 270 days. In addition to individuals, other significant investors in Short-term maturities: From the standpoint of credit risk, commercial paper include investment companies that there is generally less risk associated with holding short-term manage money market funds, trust departments of banks, issues, such as commercial paper, to maturity as compared insurance companies, corporate treasurers and state and with longer-term issues. In addition, price volatility due to local governments. short-term interest rate movements is also generally less than that associated with longer-term fixed rate issues.

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HOW IS COMMERCIAL PAPER RATED? Most commercial paper is not secured by specific assets, such Most domestic commercial paper is rated “investment as property and equipment or working capital assets, thus grade” by one or more of the four rating agencies that rate leaving creditors with no direct recourse to the company commercial paper: Standard & Poor’s, Moody’s, Fitch and assets in the event of default. In addition, while the company Duff and Phelps. Less than five percent of commercial is required to represent and warrant prior to issuance that paper is either not rated by any agency or rated below there is sufficient availability under bank lines of credit, there investment grade. The following table shows the can be no assurance that such availability will continue to be commercial paper ratings from these agencies. available at maturity of the commercial paper.

Risk of default is higher for non-rated commercial paper, COMMERCIAL PAPER RATING SCALE especially for issuers with no long-term investment grade ratings or issuers with non-investment grade long-term Rating Investment Non-Investment Agency Grade Grade ratings. These companies may be less capitalized, more leveraged or present higher business risks than rated Standard & Poor’s A-1, A-2, A-3 B commercial paper issuers. Piper Jaffray requires that Moody’s Investor Service P-1, P-2, P-3 NP investors purchasing non-investment grade commercial Fitch Investors Service F1, F2, F3 F-S paper receive an “Investing in Non-Rated Commercial Paper” brochure and complete and sign a form Duff and Phelps D-1, D-2, D-3 D-4 acknowledging the higher risks.

CONCLUSION

ASSESSING THE RISKS OF INVESTING IN For amounts of $100,000 and greater, investment grade COMMERCIAL PAPER commercial paper is an excellent investment vehicle for The major risk that the investor assumes by investing in short-term cash investors who need liquidity and lower risk. commercial paper is the risk that the issuer will not be able With a wide variety of maturities up to 270 days, to pay the debt at maturity. When evaluating the degree of commercial paper is often used by investors who need the credit risk, consideration should be given to the characteristics availability of their funds on a specific short-term date. of the issuing company, the business climate of the company Contact your Piper Jaffray financial advisor for more and the economy. This credit risk is generally mitigated by information on commercial paper, including current issuers the financial strength of most issuers, the shorter maturity and available maturities. and the availability of revolving lines of credit.