Question

What are the advantages and limitations of commercial paper?

Answer 1

Advantages of Commercial Paper

(a) The cost of issuing commercial paper is generally lower than the cost of securing commercial bank loans.

(b) It a highly liquid asset as it can be transferred to anyone at any time.

(c) Companies can invest their surplus funds in commercial paper and earn good returns on their investment.

(d) They provide a continuous source of finance to firms, as the maturing funds can be repaid by issuing fresh commercial paper.

Limitation of Commercial Paper

(a) Since commercial paper denotes unsecured securities, they can only be used by firms that have a strong market position. Therefore, new firms cannot raise money by issuing commercial paper.

(b) The amount of money that can be raised through the commercial paper is limited as it depends on the availability of funds with buyers at the time of its issue.

(c) The maturity period of commercial paper is fixed and ranges from 90 to 364 days. Therefore, if a firm is unable to redeem its commercial paper on time because of the unavailability of funds, then it cannot extend the time period of the commercial paper.