Commercial Paper

Also known as: CP, ABCP

Corporate IOUs measured in days — how blue-chip companies borrow between bond issues and bank lines.

3 min read · 590 words · Updated

1 · SnapshotThe one idea to remember
Key intuition: CP is corporate borrowing at the speed of cash management — wonderfully cheap and flexible right up until the morning the market says no.
2 · BeginnerWhat is it, really?

Commercial paper is a corporation's short-term IOU: an unsecured promise to pay a fixed amount in a few days to a few months (270 days max in the US, to stay exempt from full securities registration). Like T-bills, it sells at a discount — no coupons, just the climb to face value.

Only well-rated names can play: CP buyers — mostly money-market funds — want near-zero credit risk for near-zero time. In exchange, issuers get funding cheaper and more flexible than bank loans, tapping the market daily for exactly the amounts and dates they need (payroll Friday, tax date Tuesday).

The catch is rollover risk: CP funding must be renewed constantly. In a panic, buyers simply stop showing up — which is why every CP program is backstopped by committed bank credit lines, and why CP markets are a crisis's first casualty.

Asset class
Money markets
Instrument type
Unsecured short-term note
Traded
Dealer-placed, mostly held to maturity
Typical users
Corporates/banks (issuers), money funds (buyers)

Which risks decide the outcome

Not how risky this is, and not a rating — there is deliberately no total. It says which of five failure modes drives what happens here, in the same order on all 129 products so they can be compared. This publication's own reading; see the notice below.

  • Marketmatters
  • Creditdecides it
  • Liquiditydecides it
  • Fundingbarely applies
  • Operationalbarely applies

What decides it here. Unsecured, short and rolled constantly. The failure is not a default but a market that declines to roll it, which is what happened in 2008.

What the five mean, and which one decides where →

3 · IntermediateHow it works in practice

Market structure

  • Tiers: A-1/P-1 ("Tier 1") paper dominates; a downgrade to Tier 2 cuts the eligible buyer base drastically — a cliff issuers manage ratings around.
  • Flavours: plain corporate CP; financial CP (banks); ABCP — paper issued by conduits holding receivables/assets (the 2007 fault line, when "asset-backed" turned out to mean subprime).
  • Placement: via dealers or directly (some giants run their own desks).

Pricing drivers

CP rates sit above T-bills/OIS by a spread for credit and liquidity. The CP–OIS spread is a classic stress gauge: single digits in calm, hundreds of basis points in 2008/March 2020 — both times central banks built dedicated CP purchase facilities to reopen the market.

History lesson embedded

Lehman's failure caused the Reserve Primary money fund to "break the buck" on its Lehman CP — triggering a run on money funds, and ultimately the modern regime of money-fund reform (floating NAVs, gates) and shrunken unsecured CP reliance.

Worked example: a AA industrial issues $250M of 90-day CP at a 4.6% discount rate vs. 4.35% bills. Interest cost ≈ $250M × 4.6% × 90/360 ≈ $2.88M — likely 30–60bp cheaper than drawing its revolver, with no covenant chatter.
4 · AdvancedPricing & valuation

Valuation and spread anatomy

Priced as a credit-risky zero:

$$ P = \frac{100}{1 + (r + s)\tau}, \qquad s \approx \underbrace{\lambda(1-R)}_{\text{expected loss}} + \underbrace{\ell}_{\text{liquidity}} + \underbrace{\phi}_{\text{rollover/structural}} $$
What the symbols mean
  • Pa price, or a present value
  • rthe interest rate, per year
  • tautime remaining, in years
  • lambdaan intensity, usually of defaults per year
  • Ra return
  • phithe normal distribution's bell curve itself

For Tier-1 names expected loss over 90 days is fractions of a basis point — the spread is essentially all liquidity and structure. Term structure inside CP (overnight to 270d) steepens sharply in stress as buyers shorten.

Rollover risk formalised

Issuers model funding as a renewal process with market-shutdown states; backup lines convert liquidity risk into bank commitment fees. He–Xiong-style dynamic runs: shorter maturities are individually rational but collectively run-prone — the theoretical frame regulators apply to money-like liabilities generally.

Money-fund regulatory feedback

Prime-fund reforms (2016, 2023 US; EU MMFR) shrank the natural buyer base, migrating funding to secured (repo) and term markets; each reform round visibly repriced the CP-OIS basis and bank funding structures (the FRA-OIS/CP nexus that once drove LIBOR now lives on in €STR/EURIBOR spreads).

ABCP mechanics

Conduits fund assets with maturity-mismatched paper backed by liquidity/credit enhancement from sponsor banks — analysis is of the sponsor's support obligation as much as the assets; 2007's lesson is that "fully supported" vs. "partially supported" was the entire ballgame.

The formulas above are standard textbook formulations, simplified for teaching. They explain the mechanism — they are not a valuation tool, and they will not reproduce a dealer’s price.

5 · Desk notesHow practitioners think about it
Practitioner note: CP spreads are a barometer wired directly to the money-fund complex. When they gap, the question isn't "which issuer is sick?" but "which buyer just left the market?"

Now say it back

Close the page and give Commercial Paper in four sentences. It takes a minute and it is the only way to find out whether reading it was enough.

  1. Who wants what — two parties wanted opposite things badly enough to write it down.
  2. What the contract obliges, and when — not the payoff; the obligation.
  3. Where the money comes from — name the source, or you have described a hope.
  4. What makes it lose — the ordinary way, not the dramatic one.

Do it with a clock → · why these four

Put Commercial Paper beside any other instrument →

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