Frequently Asked Questions (FAQs) on Commercial Papers
What are Commercial Papers?
Commercial Papers (“CPs”) are unsecured short-term debt instruments issued by corporates to get funds from the public (private individuals, institutional investors, non-governmental organisations, religious bodies etc.) to meet short-term debt obligations such as working capital needs.
How do Commercial Papers work?
CPs are similar to Treasury bills (“T-Bills”) because they are issued at discount rates, which may be paid upfront or capitalized.
For instance, an investor could choose to receive N1m in the future (maturity amount/face value), which would require an ‘upfront’ investment below that face value (for instance N980,000 for a 90-day instrument at 8.0%), or could choose to invest N1m today to receive a ‘capitalized’ return above the investment amount (for instance N1.02m for a 90-day instrument at 8.0%).
What is a True Yield?
The ‘true yield’ is the effective return on investment (ROI). Using a simplified example, if an investor wants to receive N100,000 after a one-year period (365-days) and chooses to invest in a discounted instrument which is offered at a rate of 10%, the investor will pay a discounted value of N90,000 to receive N100,000 at maturity.
The true yield on that investment is not 10.0%. It is in fact 11.1%, calculated as return received as against the initial investment (N10,000/N90,000). This represents the return to the investor if the instrument is held to maturity.
The discount rate is used to calculate the present value of an investment, which differs from the yield on an investment.
Primary and Secondary Market for Commercial Papers
A CP can be purchased either in a primary or secondary market. The primary market is where investors buy financial instruments at issuance, while in the secondary market, investors trade (i.e. buy and sell) instruments purchased at primary market issuances.
The minimum purchase amount in the primary market may vary depending on the issue size. However, the minimum limit is typically set at N5m, while in the secondary market there are no standard lot sizes, but a minimum of N100m should be prepared for any purchase.
The major limitation for the secondary market trading of commercial papers is the illiquidity within the market, given that purchasers of these instruments typically only sell instruments in large volume sizes. Consequently, purchasing CPs is easier in the primary market.
What is the Tenor?
CPs are issued for time periods which match the issuer’s needs, with minimum and maximum tenors of 15 days and 270 days respectively.
What is a Commercial Paper Auction?
In the primary market, the issuer through an Issuing House sells to the market, through a fixed price subscription. Here, market participants signal interest in the issue and commit to purchasing volume sizes over an ‘offer period’ – which typically lasts only a few days.
This process is so because the rate on the issuance is fixed prior to offer to the market. This is unlike the T-Bills primary market issuances which are held in an auction format and investors are allowed to state the yields at which they would be willing to invest.
What do I Benefit from Investing in Commercial Papers?
While CPs in Nigeria are typically issued by blue-chip corporates with impressive track records of financial performance, this does not eliminate credit risk.
The discount rate on the CP is usually reflective of the credit rating of the issuer, which may be gleaned from the magnitude of the difference between the discount rate on a T-Bill with similar maturity and the CP being issued.
Consequently, CPs offer investors the opportunity to purchase better yielding instruments than available on risk-free instruments, if they are willing to take the calculated risk.
How are Commercial Papers different from Treasury Bills?
CPs have similar characteristics to T-Bills, relating to the mode of pricing. However, that is where the similarities end. T-Bills are usually issued by the government through the CBN at auctions which are typically held fortnightly, for fixed tenors of 91-days, 182-days, and 364-days.
Also, the minimum volume to participate in the T-Bills primary market auctions is N50,001,000.0, while secondary markets are very active and flexible relative to lot sizes.
Can I sell before Maturity?
Yes, you can sell CPs before maturity. A major constraint of selling CPs, however, is illiquidity and size of the minimum tradeable volume. Also, the price at which you sell depends on the prevailing interest rate at the time.
Can I rollover my CP Investment?
Usually, the answer is no. This is because a CP issuance is not a periodic auction which provides certainty of another CP investment opportunity. This, however, does not rule out the possibility of a CP investment opportunity at maturity. Nevertheless, when a CP investment matures, it can be rolled over into another money market or fixed income investment such as T-Bills and Bonds.
What are the Other Benefits of Commercial Paper?
- Interest earned is tax-exempt
- Since certificates are issued for CP investments, they can be used as collateral or as evidence of investment for visa application.
How Can I Buy Commercial Papers?
To purchase Commercial Papers, you can contact your account officer or send an email to firstname.lastname@example.org
Lagos: Adedoyin: +234 809 778 3100
Port Harcourt: Taiwo: +234 808 718 4771
Abuja: Bola: +234 909 504 1827