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Commercial Paper

Commercial Paper. Jim Kelly BA543-002 May 12, 2005. What to Expect (all in 20 Minutes). Definition A Brief History The Contemporary Commercial Paper Issuers and Dealers Buyers Credit Ratings Recent Innovations Foreign Markets Concluding Remarks Answer A Few Insightful Questions.

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Commercial Paper

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  1. Commercial Paper Jim Kelly BA543-002 May 12, 2005

  2. What to Expect (all in 20 Minutes) • Definition • A Brief History • The Contemporary Commercial Paper • Issuers and Dealers • Buyers • Credit Ratings • Recent Innovations • Foreign Markets • Concluding Remarks • Answer A Few Insightful Questions

  3. What is Commercial Paper? • Unsecured, Negotiable Promissory Note • Made Payable on a Stated Date • Typically Issued at a Discount • Short-Term: Maturity of 3 to 270 Days in the U.S. • Does Not Require SEC Registration • Maturity < 90 Days; Collateral for the Federal Reserve

  4. A Brief History Lesson • Colonial Commercial Paper: The Yanks and the Sox (See Map) • 1840s: Interest Rates First Published • The Reconstruction • The Panic of 1907 • The Great Depression • The Post-War Boom • Penn Central Crisis of 1970 • Mercury Finance Company Default of 1997

  5. The Contemporary Commercial Paper Market • Average Maturity of Commercial Paper = 30-35 Days • Small Secondary Market • Most Issuers (At Their Discretion) Continuously Roll Over Debt • Sold in Large Denominations • Commercial Paper Rates • 1½% to 3% Below the Prime Rate • 1/8% to ½% Above the T-Bill Rate

  6. Contemporary Market – Recent Growth • Explosive Growth in Commercial Paper Outstandings (12% CAGR): • 1981: $160B • 1991: $530B • 2001: $1,530B • Federal Reserve CP Statistics • Chart of Nonfinancial CP Outstandings

  7. Issuers • Finance Companies • GMAC • GE Capital • Ford Motor Credit • Merrill Lynch • JP Morgan • PepsiCo • Short-Term Needs and a Very High Credit Rating

  8. Intermediaries • Investment Banks and Commercial Bank Holding Companies Place More Than 70% of all CP. The Big Three Investment Banking Firms Are: • Goldman Sachs • Lehman Brothers • Merrill Lynch • Underwriting Spread of 5 to 10 Basis Points • Internal Sales Forces

  9. Buyers and Consumers • CP is a Highly Liquid, Low Risk Asset (See Chart) • Money Market Mutual Funds (1/3 of All CP) • Commercial Bank Trust Departments (1/4 of All CP) • Industrial Firms • Insurance Companies • Colleges and Universities • Large Corporations

  10. Creditworthiness • Credit Ratings Issued by A Credit Agency • Standard and Poor’s • Moody’s • Duff and Phelps • Fitch • Almost All Issuers Maintain 100% Backing Through Bank Lines of Credit • Credit Enhancements Are Leased from Higher-Rated Firms

  11. Credit Ratings • Strong Correlation Between Commercial Paper Debt Ratings and Term Debt Ratings • Somewhat Archaic System (Credit Cliff)

  12. Recent Innovations • Asset-Backed Securities • Special-Purpose Entities (SPEs) or Special Purpose vehicles (SPVs) • Moving Assets and Liabilities Off the Corporate Balance Sheet • FASB Does Not Require the Disclosure of Off-Balance Sheet Activities • Highly Rated Asset-Backed Paper is an Easy Sell • “Independence Day” Financed Through CP Tied to Film Receivables

  13. Foreign Markets • European Commercial Paper Market • Longer Maturities Due To Different Regulatory Environment • Active Secondary Market • Higher Default Rate • Dealers Play a Much More Active Role • Japan • France

  14. Concluding Remarks • Growth in Commercial Paper Signals Decreasing Role of Commercial Banks in Corporate Financing (See Chart) • Higher Interest Rates Increase Activity • No Significant Defaults Since 1970; The Market is Untested • Still a High Reliance on the Banking System for Insurance

  15. Questions?

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