What Is Short-Term Paper?
Short-term paper refers broadly to fixed-income securities that typically have original maturities of less than nine months. Short-term paper is usually issued at a discount and provides a relatively low-risk financing alternative for companies, governments, or other organizations to fund normal operations.
Key Takeaways
- Short-term paper is a broad category of unsecured, but relatively safe, debt with maturities that range from 90 days to nine months.
- Short-term paper is sold at a discount and then repaid at par value instead of paying regular interest or a coupon.
- Examples of short-term papers include commercial paper, short-term Treasuries, and promissory notes.
- Investors rely on depositing funds in short-term paper as it is a better source of return than cash but at the same time allows for funds to be easily accessible if needed.
- Short-term paper is issued by governments, corporations, and financial institutions.
Understanding Short-Term Papers
Short-term papers are negotiable debt instruments that are usually unsecured, but which may also be backed by assets such as securities or loans issued by a corporation. These financial instruments are sometimes considered part of the money market and are almost always issued at a discount to par and then repaid at face value upon maturity.
The difference between the purchase price and the face value of the security represents the return on investment for the holders. For the issuer, this difference represents the cost of financing the loan security. The debt security can also be issued as an interest-bearing security.
Examples of short-term paper include U.S. Treasury bills and negotiable instruments issued by financial and non-financial entities, such as commercial paper, promissory notes, and bills of exchange.
In the case of U.S. Treasury bills, the papers are backed by the full faith and credit of the U.S. government and are, thus, considered the safest investments because the government cannot default.
Investing and Issuing Short-Term Papers
Short-term papers are usually issued with a minimum denomination of $25,000. This means that the main investors of these securities are institutional investors who seek short-term vehicles to deposit their cash temporarily.
Given that short-term papers are a better alternative to holding cash in a bank account because they provided a return as opposed to cash, investors find them an attractive opportunity. Mutual funds, for instance, invest heavily in short-term paper due to their relative safety and high liquidity.
The majority of financial institutions rely on being able to roll over short-term paper for their day-to-day financing needs. During the U.S. financial-market meltdown of 2008, institutions essentially halted issuing short-term paper and the U.S. government had to intervene to provide liquidity for corporations caught without the means to finance operations.
Issuers of Short-Term Papers
Short-term paper is issued by a variety of entities, including governments, corporations, and financial institutions as they are a common form of financing the daily operations of any entity. It is a simpler form of financing than having to obtain a loan from a bank, for example. They are also easy to set up and don't require much information to be disclosed.
The issued paper is rated by a rating agency, such as , so investors understand the risk of the entity they are purchasing the short-term paper from.
Structured investment vehicles (SIV) that invest in long-term assets finance those assets by selling short-term paper with an average maturity of 90 days or less. The paper can be backed by a pool of mortgages or loans used for collateral and is, hence, referred to as short-term asset-backed paper. In the case of default, investors of the asset-backed paper can seize and sell the underlying collateral assets.
Commercial paper is a commonly used type of unsecured, short-term paper issued by corporations, typically used for the financing of payroll,accounts payable,and inventories, as well as meeting other near-term liabilities. Maturities on commercial paper typically last several days, and rarely range longer than 270 days. Commercial paper is usually issued in larger denominations, typically $100,000.
It is not uncommon for issuers to adjust the amounts and/or the maturities of papers to suit the investment needs of a particular buyer or group of buyers. Investors can purchase short-term paper directly from the issuer or through dealers who act as intermediaries between the issuer and the lender.
