Commercial Paper

Commercial paper (CP) should not be in the same category as low risk investments such as Guaranteed Investment Certificates (GICs), Treasury bills, or Canada Savings Bonds (CSBs).  Commercial paper is a short-term promissory note with a term to maturity of one month to one year. It is also available in U.S. dollars, although this introduces currency risk into the investment.

CP can be purchased through banks, other financial institutions, and investment dealers. Like other investments we have discussed, CP is issued at a discount and matures at par. The return is taxable as interest.

Commercial paper is also highly liquid, and there is an active secondary market for such issues, so that it can be easily and quickly sold at any time. Settlement is typically made within one business day.

Commercial paper is acceptable for Registered Retirement Savings Plans and Registered Retirement Income Fund accounts.

Commercial paper is issued by companies with good credit ratings. The funds raised by the corporations are used to finance their accounts receivable and inventories. Commercial Paper is guaranteed by the company that has issued the investment. This may sound risky, especially when considering that commercial paper is not backed by Canada Deposit Insurance Corporation protection. But what is key to the soundness of CP is the size, creditworthiness, and financial stability of the company making the guarantee.

Commercial paper has a fairly high minimum investment requirement – $100,000 and multiples of $1,000 thereafter. This certainly puts CP out of reach for many who are just starting to invest or whose nest egg hasn’t quite reached that level.

Over the past 40 years, only a handful of companies have failed to meet their obligations, but the investor should be aware that risk is directly associated with the financial health of the company. For example, during the financial crisis of 2008, the level of credit risk for some companies that had previously been considered very sound increased substantially – such as, companies in the auto manufacturing sector.

Terms of maturity for commercial paper are typically no longer than two months. This also contributes to the safety of the investment because it is usually assumed that the financial situation of a company can be predicted for the near future, whereas a longer term might introduce a higher level of risk arising from the uncertainty of future prospects.

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