Introduction: Corporate Short-Term Borrowing
“When large corporations need short-term funds, they don’t always go to banks—they issue Commercial Paper, tapping the money market directly.”
Commercial Paper (CP) and Certificates of Deposit (CD) are key money market instruments that allow corporates and banks to raise short-term funds. For investors, they offer higher yields than government securities but carry additional risks.
Commercial Paper (CP)
What is Commercial Paper?
An unsecured, short-term debt instrument issued by corporations to meet working capital needs.
Key Features
| Feature | Details |
|---|
| Issuer | Corporates, NBFCs, FIs |
| Maturity | 7 days to 1 year |
| Security | Unsecured (no collateral) |
| Minimum | ₹5 lakh |
| Denomination | ₹5 lakh multiples |
| Issue | Discount to face value |
Who Can Issue CP?
Eligibility Criteria:
| Criterion | Requirement |
|---|
| Rating | Minimum A3 (short-term) |
| Net worth | ₹4 crore+ tangible net worth |
| Working capital | Sanctioned by bank |
| Borrowed fund account | Standard (not NPA) |
CP Ratings
| Rating | Meaning | Risk |
|---|
| A1+ | Highest safety | Very low |
| A1 | High safety | Low |
| A2 | Adequate safety | Moderate |
| A3 | Moderate safety | Higher |
| Below A3 | Cannot issue CP | - |
Why Companies Issue CP
| Reason | Benefit |
|---|
| Lower cost | Cheaper than bank loans |
| Speed | Quick to arrange |
| Flexibility | Choose tenor and amount |
| No collateral | Unsecured borrowing |
| Diversification | Alternative to bank |
CP Yield Calculation
Discount Basis
$$Yield = \frac{Face\ Value - Issue\ Price}{Issue\ Price} \times \frac{365}{Days} \times 100%$$
Example
| Parameter | Value |
|---|
| Face value | ₹5,00,000 |
| Issue price | ₹4,85,000 |
| Days to maturity | 90 |
| Yield | (5,00,000-4,85,000)/4,85,000 × (365/90) × 100 = 12.5% |
Spreads Over T-Bills
| Issuer Quality | Typical Spread |
|---|
| AAA corporates | 30-50 bps |
| AA corporates | 50-100 bps |
| A rated | 100-200 bps |
| NBFCs | 50-150 bps (over similar corporates) |
bps = basis points (100 bps = 1%)
CP Market in India
Market Size
| Metric | Approximate |
|---|
| Outstanding | ₹5-7 lakh crore |
| Major issuers | NBFCs, PSUs, large corporates |
| Investors | Banks, MFs, corporates |
Major Issuers
| Sector | Examples |
|---|
| NBFCs | HDFC, Bajaj Finance, LIC Housing |
| PSUs | Power Grid, NTPC, ONGC |
| Corporates | Tata Group, Reliance Industries |
| Banks | Via CDs (not CP) |
Investor Base
| Investor | Share |
|---|
| Mutual funds | 40-50% |
| Banks | 25-35% |
| Corporates | 15-20% |
| Others | 5-10% |
Certificates of Deposit (CD)
What is a CD?
A negotiable money market instrument issued by banks for short-term funds.
Key Features
| Feature | Details |
|---|
| Issuer | Scheduled commercial banks |
| Maturity | 7 days to 1 year |
| Minimum | ₹1 lakh |
| Denomination | ₹1 lakh multiples |
| Form | Dematerialized |
| Negotiable | Can be traded |
CD vs Fixed Deposit
| Feature | CD | FD |
|---|
| Issuer | Banks only | Banks, companies |
| Minimum | ₹1 lakh | ₹1,000 |
| Negotiable | Yes (tradeable) | No |
| Premature withdrawal | Sell in market | With penalty |
| Rate | Market-linked | Fixed |
Why Banks Issue CDs
| Reason | Benefit |
|---|
| Liquidity management | Meet short-term needs |
| Alternative funding | Beyond deposits |
| Market-linked rates | May be cheaper than FD |
| Flexibility | Choose tenor |
Risks in CP and CD
Credit Risk
The Primary Risk:
- Issuer may default
- CP is unsecured
- CD backed by bank, but bank can fail
Historical Examples:
| Event | Impact |
|---|
| IL&FS default (2018) | CP holders faced losses |
| DHFL stress (2019) | CP market frozen |
| Yes Bank (2020) | CD holders affected |
Liquidity Risk
| Situation | Impact |
|---|
| No secondary market | Can’t sell before maturity |
| Market stress | Wider bid-ask spreads |
| Issuer-specific news | Hard to exit |
Interest Rate Risk
| Scenario | Impact |
|---|
| Rates rise | Existing CP/CD worth less |
| Rates fall | Existing CP/CD worth more |
| Hold to maturity | No impact |
Reinvestment Risk
| Risk | Description |
|---|
| Maturity | May get lower rate on rollover |
| Rates fallen | Reinvest at lower yield |
How to Invest
Direct Investment
For Institutional/HNI:
| Step | Action |
|---|
| 1 | Contact issuing company/bank |
| 2 | Submit application |
| 3 | Transfer funds |
| 4 | Receive in demat |
Minimum: ₹5 lakh (CP), ₹1 lakh (CD)
Through Mutual Funds
For Retail Investors:
| Fund Type | CP/CD Exposure |
|---|
| Liquid funds | Significant |
| Ultra short duration | High |
| Money market funds | High |
| Low duration funds | Moderate |
Checking Fund Portfolio
What to Look For:
- Issuer quality (credit rating)
- Concentration (single issuer limit)
- Maturity profile
- Historical defaults
Mutual Fund Regulations
SEBI Rules for CP/CD
| Rule | Requirement |
|---|
| Single issuer limit | ≤10% of AUM |
| Sector limit | ≤20% for NBFCs/HFCs |
| Rating | Minimum A1 for liquid funds |
| Valuation | Mark-to-market |
Post-IL&FS Changes
| Change | Purpose |
|---|
| Stricter rating focus | Avoid low-quality paper |
| Graded exit load | Prevent runs |
| Side pocketing | Isolate stressed assets |
| Enhanced disclosure | Transparency |
Analyzing CP/CD Issuers
What to Check
| Factor | What to Look For |
|---|
| Credit rating | A1+ preferred |
| Parent company | Strong parentage |
| Financial health | Liquidity, leverage |
| Repayment history | No past defaults |
| Sector | Cyclical vs stable |
Red Flags
| Warning Sign | Concern |
|---|
| Rating downgrade | Deteriorating credit |
| High leverage | Stress possibility |
| Concentrated exposure | Single sector/borrower |
| Asset-liability mismatch | Liquidity risk |
| Governance issues | Management quality |
| Source | What You Get |
|---|
| MF factsheets | Portfolio holdings |
| CRISIL/ICRA | Rating reports |
| Bloomberg/Reuters | Market rates |
| Company filings | Financial data |
Current Market Conditions
Typical Yields (Approximate)
| Instrument | Tenor | Yield Range |
|---|
| AAA CP | 3 months | 7.0-7.5% |
| AA CP | 3 months | 7.5-8.5% |
| Bank CD | 3 months | 7.0-7.5% |
| T-Bill | 3 months | 6.5-7.0% |
Yields change with market conditions
Spread Analysis
| Spread | Indicates |
|---|
| CP-T-Bill narrow | Low credit concern |
| CP-T-Bill wide | Credit stress |
| NBFC-Corporate wide | Sector concern |
Key Takeaways
- CP is unsecured – Credit risk is real
- CD is bank issued – Still has bank risk
- Higher yields – Compensate for credit risk
- Ratings matter – A1+ safest, avoid below A3
- MF route – Best for retail investors
- Diversification – Don’t concentrate
- Monitor – Watch for rating changes
Disclaimer
This article is for educational purposes only. CP and CD investments carry credit risk. Defaults can lead to loss of principal. Past returns don’t guarantee future performance. This is not investment advice.
Frequently Asked Questions
Q: Can I buy CP or CD directly?
A: Technically yes, but minimum is ₹5 lakh (CP) or ₹1 lakh (CD). For most retail investors, liquid funds are more practical and diversified.
Q: Are CDs safer than CP?
A: Generally yes—CDs are issued by banks which are regulated and have deposit insurance (though CD specifically not covered). But bank failures can occur.
Q: Why did liquid funds lose money in 2018?
A: IL&FS and related entities defaulted on their CP. Funds holding this paper had to write down value, causing NAV drops. This was credit risk materializing.
Q: How do I check if my liquid fund holds risky paper?
A: Check monthly portfolio disclosure on AMC website. Look at credit ratings of holdings, concentration in single issuers, and NBFC exposure.
Q: Is higher yield in CP worth the risk?
A: Depends on your risk tolerance. For emergency funds, stick to T-Bills or government-focused liquid funds. For yield enhancement with some risk, high-quality CP is acceptable.
Commercial Paper and CDs are the lifeblood of corporate short-term financing. Understanding them helps you evaluate liquid fund risks and make informed choices about where to park your short-term money.
