5.2.3The commercial paper market

As Table 5.1 shows, commercial paper (CP) is the other money market instrument

whose return is expressed on a discount basis. Commercial paper is issued by large

corporations as a form of short-term borrowing. Its initial maturity is usually between

seven and forty-ve days. It is sold at a discount to its maturity value, and the return

is thus calculated in exactly the same way as for bills, in eqn 5.1. Commercial paper

is normally unsecured against any specic assets and rms wishing to use the com-

mercial paper market will usually seek a credit rating from one or other of the credit

rating agencies, since a high rating will mean that such paper can be issued at a

smaller discount, often amounting to the equivalent of 1 per cent. As a source of

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5.2 The ‘parallel’ markets

nance, commercial paper serves a similar purpose to commercial bills (and is priced

in the same way). Thus, in countries like the UK where there is a highly developed

discount, or bills, market, the market for commercial paper is relatively small. By

contrast, in France and the US, where the commercial bill market is less developed,

the commercial paper market is very large. The main difference between commercial

paper and commercial bills lies in the manner of their creation. A rm borrows via

a commercial bill when it agrees to ‘accept’ a bill which is ‘drawn’ by a creditor. The

bill originates with the lender. A rm borrows via commercial paper when it issues

the paper itself.

5.2.4The local authority market

As its name implies, this is a market in which funds are lent to local authorities.

Strictly speaking, we are interested here only in one part of the market, that part

which supplies local authorities with short-term ‘money’ through bills and deposits.

We need to remember that local authorities are also active in the ‘capital’ markets

where they borrow by the issue of stocks, bonds and mortgages.

Bills are issued with maturities of three and six months. They are in most respects

similar to treasury bills, including the eligibility for rediscount at the Bank of England.

Consequently they are held and traded by those active in the traditional bill market

and yields are always very close to treasury bill yields.

However, deposits are a much larger source of funds than are bills. They are normally

short and xed term, though some are overnight (‘at call’) deposits and some are for

364 days. As we must now expect, the size of the deposits is large, usually over £50,000,

with £1m quite common. The deposits once made cannot, unlike CDs, be traded.

The source of deposits ranges from banks lending their own surpluses, to large rms

and other nancial institutions and to institutions arranging deposits for overseas

depositors. Given the size of the deposits and the other terms and conditions, local

authority deposits are bound to function for lenders as an alternative to deposits in

the interbank market.