What Is Commercial Paper? How It Works and Examples

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Commercial paper is an unsecured, short-term debt instrument that corporations and financial institutions issue to raise cash for near-term needs such as payroll, inventory and accounts receivable. In the United States it usually matures in 270 days or less. It is typically sold at a discount to its face value, and the investor collects the full face value at maturity. Because no collateral backs it, its safety rests on the issuer’s ability to pay. In practice, that means only large companies with strong credit ratings can sell it at attractive rates.

What Commercial Paper Is, Precisely

In money-market usage, a piece of commercial paper is a promissory note: the issuer’s written promise to pay a fixed sum on a fixed date. It is not secured by any specific assets, does not pay periodic interest in its standard form, and is meant to be repaid out of short-term cash flows or new borrowing.

Three features define it:

• Short maturity. In the U.S., the 270-day ceiling comes from securities law (explained below), not market custom alone.
• Unsecured. Investors have a general claim on the issuer, not a lien on inventory, receivables or property. The exception is asset-backed commercial paper, covered later.
• High credit quality. Issuers almost always carry top short-term ratings from credit rating agencies. Without that rating, buyers would demand a much steeper discount, and the cost advantage over bank borrowing would disappear.

The term “corporate paper” is sometimes used as a synonym, and traders often abbreviate it to “CP.”

How Commercial Paper Works

Issuance at a discount

Suppose a company sells a note with a $1 million face value maturing in 60 days. It might receive $992,000 now and repay $1 million at maturity. The $8,000 difference is the investor’s return and the issuer’s cost of borrowing. Paper sold this way is effectively a zero-coupon instrument, with one cash flow in (the purchase price) and one out (the face value).

Some issuers instead sell interest-bearing paper at face value and pay the face value plus accrued interest at maturity. The economics are similar. The difference is only in how the return is quoted and paid.

Commercial paper programs

Companies rarely issue a single note. They set up a commercial paper program: a standing framework, with legal documentation and agreements with dealers, under which they can issue notes repeatedly up to an authorized maximum. A treasurer can then borrow for exactly the days and amount needed, sometimes issuing paper daily.

Paper reaches investors in two ways:

• Dealer-placed paper. Investment banks act as dealers, buying paper from the issuer and reselling it to investors, or selling it on the issuer’s behalf for a fee.
• Directly placed paper. Very large, frequent issuers, often finance companies and banks, sell straight to investors and skip the dealer’s fee.

Rolling over

Commercial paper is short, but the funding need behind it often is not. A company that uses paper to finance a permanent level of inventory will repay maturing notes by issuing new ones. This is called rolling over. As long as investors keep buying, the company has continuous short-term funding at money market rates.

Rollover is also the market’s weak point. If investors stop buying, because the issuer’s credit weakens or because the whole market seizes up, the company must find cash to repay maturing notes all at once. For that reason, issuers typically maintain backup lines of credit with banks, and rating agencies look at that liquidity support when they rate a program.

The 270-day rule in U.S. law

The Securities Act of 1933 generally requires securities sold to the public to be registered with the Securities and Exchange Commission. Section 3(a)(3) of the Act exempts notes that arise out of current transactions and mature in no more than nine months. That is why U.S. commercial paper is capped at 270 days, and why proceeds under this exemption are meant to fund current assets such as inventory and receivables rather than fixed assets like a new plant. Paper that does not fit that exemption can still be sold privately to sophisticated investors under the private-placement exemption, often called “4(a)(2) paper,” which comes with resale restrictions.

The exemption saves issuers the time and cost of registration. It does not mean the paper is unregulated: anti-fraud rules still apply, and the money market funds that buy much of it face their own SEC limits on credit quality and maturity.

The Formula: Pricing and Yield

U.S. commercial paper is usually quoted on a discount basis using a 360-day year, the same convention as Treasury bills. The core formulas:

Discount (in dollars) = Face value × Discount rate × (Days to maturity ÷ 360)

Price = Face value − Discount

The quoted discount rate understates the investor’s true return, because the discount is measured against face value even though the investor only paid the lower price. To compare paper with other investments, convert it to a yield on the amount actually invested:

Money market yield (360-day basis) = (Discount ÷ Price) × (360 ÷ Days)

Bond-equivalent or investment yield (365-day basis) = (Discount ÷ Price) × (365 ÷ Days)

These are simple-interest annualizations. They do not compound, which keeps them comparable with other money market quotes but makes them slightly different from an annual percentage yield.

Example of Commercial Paper

Hypothetical example. All figures below are illustrative, not current market rates or any company’s actual terms.

A retailer expects heavy holiday sales and needs cash to stock up on inventory in the fall. It issues commercial paper with a face value of $1,000,000, a maturity of 90 days, and a quoted discount rate of 5%.

1. Discount: $1,000,000 × 0.05 × (90 ÷ 360) = $12,500
2. Price paid by the investor: $1,000,000 − $12,500 = $987,500
3. Return over 90 days: $12,500 ÷ $987,500 = 1.266%
4. Money market yield: 1.266% × (360 ÷ 90) = about 5.06%
5. Investment yield (365-day basis): 1.266% × (365 ÷ 90) = about 5.13%

The retailer receives $987,500 today, buys inventory, sells it through the holiday season, and repays $1,000,000 on day 90. The investor, perhaps a money market fund, earns $12,500 for lending $987,500 for three months. If the merchandise is still on shelves when the note comes due, the retailer would likely issue new paper to repay the old, which is exactly the rollover dependence described above.

Reading the result

• A higher discount rate means a lower price and higher cost for the issuer.
• For the same discount rate, a longer maturity produces a larger dollar discount.
• The gap between the quoted discount rate and the investment yield widens as rates and maturities increase.

How Commercial Paper Is Used

By issuers

Companies use commercial paper to fund the gap between paying for things and getting paid. Typical uses include:

• Inventory, especially for seasonal businesses that build stock ahead of peak demand.
• Payroll and operating expenses while receivables are outstanding.
• Accounts receivable financing, a major reason finance companies and the financing arms of manufacturers are heavy issuers.
• Bridge funding until longer-term financing, such as a bond issue, is completed.

For a highly rated company, commercial paper is often cheaper than a bank loan, because it borrows directly from investors and does not pay a bank’s lending margin. That lowers its short-term funding cost and, when short-term debt is a meaningful part of its capital structure, its weighted average cost of capital.

By investors

The buyers are dominated by institutions, in part because of the $100,000 typical minimum. The SEC has described the investor base as including investment companies, retirement accounts, state and local governments, and financial and non-financial firms. In practice:

• Money market funds are among the largest buyers. Commercial paper’s short maturity and high credit quality fit their mandate of preserving principal and liquidity while earning a modest return.
• Corporate treasurers park surplus cash in high-grade paper that matures when the cash will be needed.
• Banks use it in asset-liability management, matching short-term assets against short-term liabilities. A bank with obligations due in 60 days could hold 60-day paper so the two mature together.
• Pension funds, insurance companies and other institutional managers hold it as a cash-like allocation.

By individuals

Individuals rarely buy commercial paper directly because of the denomination size. The usual route is indirect: money market funds, short-term bond mutual funds and some exchange-traded funds hold commercial paper, so their shareholders get exposure to it in small amounts with diversification across many issuers.

Types of Commercial Paper and Related Instruments

Unsecured corporate commercial paper

This is the standard form described above: an unsecured promissory note from a highly rated corporation or financial institution. Within it, the market distinguishes between financial issuers (banks, finance companies) and non-financial issuers (industrial and consumer companies), and between paper eligible under the 3(a)(3) exemption and privately placed 4(a)(2) paper.

Asset-backed commercial paper (ABCP)

ABCP is issued by a special-purpose vehicle, often sponsored by a bank, that holds a pool of assets such as trade receivables, auto loans or credit card balances. Investors are repaid from the cash those assets generate and from new ABCP issuance. Unlike standard paper, it is backed by specific assets selected by the sponsor, and it usually comes with liquidity support from a bank. ABCP’s reliance on rollover became a central problem in the 2007 to 2008 credit crisis, when investors refused to refinance many vehicles.

Instruments often grouped with commercial paper

Promissory notes, drafts, bankers’ acceptances, certificates of deposit and repurchase agreements are sometimes listed as “types” of commercial paper, a grouping that reflects the term’s broader legal meaning (see the next section). In money market terms, only the promissory note is commercial paper in the strict sense; the others are related short-term instruments.

• Promissory notes. The form money market commercial paper takes, sold at a discount and redeemed at face value.
• Drafts. An order from one party (the drawer) directing another, usually a bank, to pay a third party. A sight draft is payable on demand; a time draft is payable on a set future date. An ordinary check is a type of draft.
• Bankers’ acceptances. A time draft that a bank has accepted, meaning the bank itself promises to pay at maturity. They are used in international trade and can trade before maturity. The bank’s guarantee is what separates them from unsecured corporate paper.
• Certificates of deposit (CDs). Fixed-rate, fixed-term bank deposits; smaller CDs may carry deposit insurance up to a limit. Large negotiable CDs trade in the money market alongside commercial paper because they are short and liquid.
• Repurchase agreements (repos). One party sells securities to another and agrees to buy them back at a set price on a future date. The price difference works as interest and the securities serve as collateral, so a repo is a secured short-term loan.

What Commercial Paper Is Often Confused With

Commercial paper in the legal sense

In U.S. commercial law, “commercial paper” historically meant negotiable instruments in general: promissory notes, drafts, checks and certificates of deposit, governed today by Article 3 of the Uniform Commercial Code. That legal category is much broader than the money market instrument. It explains why a paycheck written as a check can fall under “commercial paper” in a law school sense while having nothing to do with corporate short-term borrowing.

Commercial paper vs. bonds

Both are debt, but they differ in almost every practical term:

• Maturity: commercial paper runs from 1 to 270 days in the U.S.; corporate bonds typically mature in 1 to 30 years.
• Payments: standard commercial paper makes a single payment at maturity. Most bonds pay coupons at regular intervals, often twice a year, and return principal at maturity.
• Security: commercial paper is unsecured (except ABCP). Bonds can be secured or unsecured; long-dated debt is more often secured because investors want a claim on assets over a longer horizon.
• Registration: public bonds are generally registered with the SEC; exempt commercial paper is not.
• Ratings: commercial paper carries short-term ratings, while bonds carry long-term ratings on a different scale.

Commercial paper vs. Treasury bills

Both are short-term discount instruments quoted on similar conventions and traded in the money market. The difference is the borrower: T-bills are obligations of the U.S. government, while commercial paper depends on a single company. Investors therefore expect commercial paper to yield more than a T-bill of the same maturity, and that spread is a gauge of how much credit and liquidity risk the market is pricing.

Commercial paper vs. bank loans and credit lines

A bank loan or revolving credit line involves negotiation, covenants and a relationship with a lender. Commercial paper borrows directly from the market, usually at a lower rate for top-rated issuers, but with no lender committed to roll the debt. Many companies use both: paper for day-to-day funding and an undrawn credit line as a backstop.

Commercial paper vs. commercial bills

A commercial bill (bill of exchange) is a trade instrument drawn by a seller on a buyer for goods supplied, and it is often discounted with a bank. Commercial paper is not tied to a specific shipment or sale; it is a general borrowing by the issuer. Historically the two are related: commercial paper grew out of the bills of exchange used in colonial-era trade.

Commercial paper vs. hot money

“Hot money” is capital that moves quickly between markets or countries in search of higher short-term returns. It describes investor behavior, not a security. Yield-chasing money market funds can make commercial paper funding behave like hot money, quick to flow out when sentiment turns.

A Brief History

Commercial paper’s roots lie in the bills of exchange used by merchants in colonial America. Later, New York merchants sold their short-term obligations to dealers, who bought the notes at a discount from par and resold them to banks and other investors; the merchants then repaid the holders at par. Marcus Goldman, founder of Goldman Sachs, is credited as the first money market dealer to buy commercial paper, and his firm became one of the largest commercial paper dealers in the country after the Civil War.

The market’s modern risks were exposed in two well-known episodes. In 1970, the Penn Central railroad defaulted on its commercial paper, showing investors that highly regarded issuers could fail. In September 2008, Lehman Brothers’ bankruptcy caused losses on its paper that led the Reserve Primary Fund to “break the buck,” meaning its share value fell below $1. Investors pulled cash from money market funds, demand for commercial paper collapsed, and the Federal Reserve created the Commercial Paper Funding Facility to buy paper directly from issuers. The Fed revived a version of the facility in 2020 when the pandemic disrupted short-term funding markets.

Limitations and Risks of Commercial Paper

• Credit risk. The issuer can default. Because standard paper is unsecured, investors rely entirely on the issuer’s financial strength, and a rating can be cut quickly.
• Rollover risk. A downgrade or market-wide stress can shut an issuer out of the market just when its paper comes due.
• Restricted access and use. Weaker firms face prohibitive discounts or no buyers, and proceeds under the 3(a)(3) exemption should fund current transactions, not fixed assets.
• Modest returns. The low cost that attracts issuers translates directly into low yields for investors.
• Limited secondary market. Most buyers hold paper to maturity. Dealers may buy back paper they placed, but selling early is not as simple as selling a Treasury bill.
• High minimum size. The typical $100,000 denomination keeps most individuals out of direct ownership.

Investors who buy commercial paper through a money market fund still carry these risks indirectly, spread across the fund’s holdings and subject to the fund’s own rules.

FAQs

The Bottom Line

Commercial paper matters most to corporate treasurers seeking cheap short-term funding and to institutions, especially money market funds, that need a safe place for cash. Highly rated issuers can borrow below bank rates, but they depend on investors to keep rolling their paper over, so backup credit lines are standard. Individuals usually get exposure through money market funds, where issuer default and rollover risk still apply, spread across many issuers.