In a previous article we wrote about a Passive Investment option known as Money Market Funds, which you can check out here if you have not. In this article, we want to bring to light another passive investment option known as Commercial Papers. Of course, they are passive in that after making the investment you do not require any further activity or work for them to yield interest or dividends for you. Essentially, your money works for you.
What are Commercial Papers?
Commercial papers are short-term, unsecured promissory notes issued by corporations and financial institutions to raise funds for their immediate needs, such as working capital or financing short-term liabilities. They are money market instruments with maturity typically ranging from a few days to 270 days (reason why they are short-term). Essentially, issuing commercial papers is a way for large, creditworthy companies to borrow money directly from investors, often at lower interest rates than traditional bank loans.
A commercial paper is described as unsecure because it is not backed by any collateral, but only by the issuers creditworthiness. Usually corporations and financial institutions are issued credit ratings which are made public, and can serve as a criterion for investors to consider before investing in the scheme.
How Does Commercial Paper Investment Work?
When a commercial paper is issued by a corporation, it is done at a discount to the face value usually at a similar rate to prevailing market interest rates or slightly above, such that investors only have to invest the discounted amount and receive the full face value at maturity. An example, if a company issues a commercial paper with a 20% discount, an investor who wants to invest $10,000 would be required to invest only the discounted amount and at maturity would receive back payment of the full face value of $10,000... tantamount to receiving one's interest upfront.
The discount rates (interest rate) are usually attractive compared to interest on Savings accounts and treasury bill rates. From our observation the lower the credit rating of the issuing corporation the more attractive the interest rate, more like to make up for their low credit rating and to attract investors. As at today, with Nigeria's Inflations rate at circa 23%, some Commercial papers offer as high as 21% per annum discount/interest on investment, with implied yields of up to 25% per annum.
Note that although Commercial papers are short term, they are not as flexible or liquid for investors as Money Market funds as described in our previous article, and an investor who subscribes to a commercial paper would usually have to wait till maturity (end of the investment period) before receiving payment of their principal (even though the interest or discount is given upfront). However, some of them are registered on the FMDQ and are tradable but not as flexibly as Money Market Funds. Most commercial papers also have specified minimum investments or subscription amounts, which could be quite high for retail/individual investors. For instance the most recent Dangote Sugar Refinery PLC Commercial Paper issuance specified a minimum subscription of ₦5million and ₦1thousand there after. But it is worth considering if an investor can afford to subscribe.
To invest in commercial papers in Nigeria, an investor has to open a trading account with a stockbroking firm and have a CSCS (Central Securities Clearing Systems) account.
Comments
Post a Comment