Commercial Paper
Also written CP · Commercial Paper (CP)
A short-term, unsecured, discounted money market instrument through which eligible companies raise funds for 7 days to one year, issued in Rs 5 lakh multiples.
In plain language
A company that needs money for a few weeks, to pay suppliers or meet a seasonal gap, does not want a long bank loan. If it is creditworthy enough, it can borrow directly from investors by issuing Commercial Paper (CP).
A CP is a short-term IOU. It is unsecured, so investors rely on the issuer's credit standing. It is discounted: investors pay less than face value now and receive face value at maturity. And it must be rated, issued in demat form and handled through an Issuing and Paying Agent (IPA).
For Series VII the CP matters for a second reason. A stock broker running a margin trading facility is allowed to fund it partly by issuing CPs.
How it works
From Chapter 1 (section 1.3) of the workbook:
| Feature | Workbook rule |
|---|---|
| Purpose | Indian corporates raising short-term unsecured funds |
| Pricing | Discounted instrument, like T-bills |
| Denomination | Rs 5 lakh and multiples thereof |
| Maturity | Between 7 days and one year |
| Regulation | RBI regulations |
| Form | Dematerialised, held with a SEBI-registered depository |
| Minimum rating | 'A3', assigned by a Credit Rating Agency as per SEBI's rating symbols |
| Agent | An Issuing and Paying Agent (IPA) for each issue |
Who can issue. Companies, including NBFCs and All India Financial Institutions, provided any fund-based facility they have from banks or financial institutions is classified as a standard asset by all financing banks/institutions at the time of issue. The workbook then extends eligibility, in its words, to "other entities like co-operative societies/unions, government entities, trusts, limited liability partnerships and any other body corporate having presence in India with a net worth of Rs. 100 crore or higher subject to the condition as specified by RBI".
Brokers and CPs (Chapter 8, margin trading facility). To fund MTF, a stock broker may use own funds, borrow from scheduled commercial banks and/or RBI-regulated NBFCs, issue CP, or take unsecured long-term loans from promoters and directors. CP borrowing must follow RBI guidelines. No other source is permitted, and client funds may not be used for MTF.
A worked example
Issue price and size are illustrative; the rules are the workbook's.
Sharma Securities Ltd, a stock broker, wants Rs 25 crore to expand its margin trading book for three months.
- It issues 500 CPs of Rs 5,00,000 face value each: 500 × Rs 5,00,000 = Rs 25 crore face value. The maturity (about 90 days) is within the 7-day to one-year window.
- It must hold at least an A3 rating and appoint an IPA. The CPs are issued in demat form.
- Investors pay Rs 4,90,000 per CP: 500 × Rs 4,90,000 = Rs 24.50 crore raised.
- At maturity Sharma Securities repays Rs 25 crore. The cost of borrowing is Rs 25 crore − Rs 24.50 crore = Rs 50 lakh.
What it could not do: top up the MTF book with money lying in clients' accounts. Client funds are expressly barred from use in margin trading.
Why NISM asks about it
Chapter 1 (section 1.3, Money Market) tests CP features: issuer eligibility, the Rs 5 lakh denomination, the 7-day to one-year maturity, the A3 minimum rating, the Rs 100 crore net worth for other entities and the IPA. Chapter 8 (margin trading facility) tests the permitted sources of a broker's MTF funding, where CP is one of the allowed routes. Section 1.4.3 also lists CPs among securities an issuer may place through the EBP platform, and section 1.3 lists them as eligible securities for corporate bond repo.
Common exam traps
- CP is unsecured. Do not confuse it with a secured debenture.
- CP versus CD. Same denomination and maturity band; CPs are issued by corporates and other eligible entities, CDs by banks.
- Minimum rating is A3, not AAA or A1.
- Two different eligibility tests. Companies, NBFCs and AIFIs need their bank facilities to be a standard asset; the Rs 100 crore net worth figure sits in the sentence about other entities such as trusts, LLPs and other bodies corporate.
- A broker can borrow via CP for MTF, but never from client funds and never from sources outside the SEBI list.
Where this is taught
- Series IV · Chapter 1: Introduction to Interest Rate, Interest Rate Instruments and Fixed Income Marketsintroduced here
- Series II-A · Chapter 3: Characteristics of Debt Securitiesintroduced here
- Series VI · Chapter 11: Special Services - Debt Instruments & Government Securitiesintroduced here
- Series X-A · Chapter 9: Investing in Fixed Income Securitiesintroduced here
- Series VII · Chapter 1: Introduction to Securities Marketintroduced here
Related terms
- Certificate of DepositA negotiable, unsecured money market instrument issued by a bank against funds deposited with it, sold at a discount and repaid at face value within one year.
- Margin trading facilityA SEBI-regulated facility in which a stock broker lends part of the purchase price of eligible shares or equity ETFs to a client, holds the bought stock as pledged collateral and charges interest.
- RepoA ready forward contract: borrowing money by selling securities with an agreement to buy them back later at a higher price that includes the interest.
- Issuing & Paying AgentThe agent through which a commercial paper issue is allotted: it receives investors' demat details from the issuer, issues the IPA certificate and provides the allotment file used to credit CPs to demat accounts.
- Electronic Book ProviderThe stock exchange platform on which privately placed debt securities above SEBI's thresholds must be bid for electronically, with published issue details and system-computed cut-offs.
- Money Market InstrumentsDebt instruments with maturity of one year or less. Under the PM Regulations they include commercial paper, trade bills, treasury bills, certificates of deposit and usance bills.
- Bond Equivalent YieldThe annualised simple-interest return on a money market instrument, computed on price and a 365-day year, so instruments of different maturities can be compared on one basis.
- Debt securityA written agreement to repay a loan, usually with interest, within a set time. Bonds, debentures, CP, CDs, G-Secs and T-Bills are all debt securities, and any type can be admitted to the depository.
- IPA certificateThe certificate an Issuing and Paying Agent provides on the allotment date of a commercial paper issue, confirming the allotment, and which the seller must forward to the buyer in every secondary-market trade.
- Term moneyUnsecured lending or borrowing between banks for a period of 15 days to 1 year, dealt and reported on the RBI's NDS-CALL platform, the longest tenor of the interbank call market.
- Call moneyUncollateralised overnight lending and borrowing of funds between scheduled commercial banks and primary dealers — the shortest segment of the Indian money market.
- Cash Management BillsVery short-term discounted Treasury Bills of under 91 days, issued by the Government of India to bridge temporary mismatches in its own cash flow.
- Financial disintermediationThe shift of borrowing away from banks and towards the securities markets, where a company raises money directly from investors by issuing paper instead of taking a bank loan.