Readers Question. I was just reading the wiki page about Commercial Paper and I understand the gist of it; however, one thing that always confused me about it is:
Since commercial paper is a cheaper alternative to a bank line of credit for companies to finance their daily operations, wouldn’t it make sense to just use savings as a direct means of funding? Why borrow (with interest) when you already have a lot of cash?
Please demystify this conundrum. Thanks so much and sorry to hear about the mortgage interest rates not being passed on.
Commercial Paper is a way to borrow money in the short term. Commercial paper is a security with a maximum period of 9 months (270 days)
Commercial paper is not issued with collateral but just a guarantee from bank or corporation to repay the debt at the maturity period.
Why Do Firms Borrow When they have Cash Savings?
I think the reason is that they wish to have a certain buffer of cash savings, for emergencies. For example, a firm may wish to have a buffer of say £1 million cash or 1% of their turnover. Therefore, if they are short of money, rather than dip into savings they will issue commercial paper raise funds on the money markets. If they ran down their savings then they could get caught out, if money markets froze. So although they lose a small amount of interest on these loans. It is safer and less risky than running down their cash reserves.
Makes sense 🙂
Thank you!