Commercial Paper represents unsecured promissory notes issued firms to raise short term funds. Only large companies enjoying high credit rating and sound financial health can issue commercial paper to raise short term funds.
RBI has laid a number of conditions to determine eligibility of a company for the issue of a commercial paper. Only a company which is listed on the stock exchange has a net worth of at least Rs.10 crores and a maximum permissible bank finance of Rs.25 crores can issue commercial paper not exceeding 30 percent of its working capital limit.
It is sold at a discount from its face value and redeemed at face value on its maturity. Hence the cost of raising funds in this way, is a function of the amount of discount and the period of maturity and no interest rate is provided by the RBI for this purpose. Commercial papers are normally bought by investors including banks, insurance companies, unit trusts and firms to invest surplus funds for a short period.
A credit rating agency called CRISIL has been set up in India by ICICI and UTI to rate commercial papers. Commercial paper is a less costly source of raising short-term funds as compared to the bank credit and proves to be effectual even at the time of rigid terms of bank credit.
Commercial paper is a cheaper source of raising short term finance as compared to bank credit. However, it can be used as a source of finance only by large companies enjoying high credit rating and sound financial health.
Main disadvantage is that it cannot be redeemed before the maturity date even if the issuing firm has surplus funds to pay back.
