Question

What is a commercial paper? What are its advantages and limitations.

Answer 1

Answer:

Commercial paper :

Commercial paper is promissory note. It is  unsecured . Commercial papers are issued by one firm to other firm or an insurance company or Bank for shorter period. RBI (Reserve Bank of India) regulate the issue of commercial papers.Commercial papers are short term financing instruments for the company.

Advantages of commercial papers :  

(1) commercial papers are non restrictive because they are sold on unsecured basis.  

(2) Commercial papers are freely transferable like shares of a company due to which they can be converted into cash anytime.  

(3) Commercial papers are effective for the companies needing high amount of funds in the short-term as the cost of issuing commercial paper is less than the cost of arranging a bank loan.

(4) The maturity range of commercial paper is in the range of 92 to 364 days.

(5) Companies can invest in commercial papers to earn good return out of the excess cash flow generated through their business.  

LIMITATIONS OF COMMERCIAL PAPER :  

(1) As the commercial papers are unsecured  they can be issued by only highly rated firms having a good past record of profitability . New companies cannot issue commercial papers.  

(2) The size of the issue of the commercial papers is limited to the extent that the liquidity available at a particular time should be in excess of the required working capital of the company.  

(3) The commercial papers are issued for a fixed maturity period which cannot be extended. So, if a company gets into a financial difficulty, it cannot extend the maturity period and the redemption has to be made whenever due.

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Answer 2

Answer:

Advantages of commercial papers:

1) It is quick and cost effective way of raising working capital.

2) Best way to the company to take the advantage of short term interest fluctuations in the market

3) It provides the exit option to the investors to quit the investment.

4) They are cheaper than a bank loan.

5) As commercial papers are required to be rated, good rating reduces the cost of capital for the company.