Commercial Paper

Money-market instruments such as T-bills, commercial paper, and CDs are:

1. A.Tax-free municipal bondsThe three instruments named in the stem come from corporate, bank, and federal issuers, and their interest is generally taxable. Money-market status is defined by short maturity, not by tax treatment.
2. B.Illiquid real estateReal estate is the standard example of an asset that cannot be converted to cash quickly. These instruments are held precisely because they can be, which is the opposite quality.
3. C.Long-term equityEvery instrument listed in the stem is a debt obligation with a stated maturity date, and none conveys ownership in a company. They also mature inside a year, so nothing about them is long-term.
4. D.Short-term and highly liquidCorrect - short maturities, high liquidity.

Why: Money-market instruments are short-term and highly liquid, with maturities of one year or less.

Bellweather Logistics needs roughly 90 days of financing to carry seasonal inventory, and its treasurer proposes raising the money by issuing commercial paper. Which statement about commercial paper is accurate?

1. A.It must be registered under the Securities Act of 1933 like any other corporate obligation, regardless of its maturityRegistration would defeat the purpose of a 90-day funding tool. The short-term paper exemption exists precisely so issuers can raise working capital quickly.
2. B.It is issued only by banks and, like a deposit account, carries FDIC insurance up to the applicable limitThis confuses commercial paper with negotiable certificates of deposit. Commercial paper is issued by corporations and finance companies, and carries no insurance of any kind.
3. C.It is collateralized by the issuer receivables and pays interest semiannually like a corporate bondCommercial paper is unsecured and pays no periodic coupon. Asset-backed commercial paper is a separate structured product; plain commercial paper rests on the issuer general credit.
4. D.It is unsecured short-term corporate debt issued at a discount, and it is exempt from Securities Act registration when its maturity does not exceed 270 daysCorrect on both counts: no collateral, no stated coupon (the return is the discount), and the 270-day exemption is the reason issuers cluster maturities under nine months.

Why: Commercial paper is unsecured, short-term corporate debt sold at a discount from its face amount, with the investor return coming from the difference between the discounted purchase price and the face value paid at maturity. Under Section 3(a)(3) of the Securities Act of 1933 it is exempt from registration when it matures in 270 days or less and the proceeds fund current operations, which is why issuers almost always keep maturities inside that window.

Commercial paper is best described as...

1. A.A secured long-term corporate bondCommercial paper is unsecured and short-term, not a long-term secured bond.
2. B.A municipal money-market noteCommercial paper is corporate, not municipal.
3. C.A federally insured certificate of depositCommercial paper is uninsured corporate debt, not a bank CD.
4. D.Unsecured short-term corporate debt issued at a discount, maturing in 270 days or lessCorrect — that is the standard description of commercial paper.

Why: Commercial paper is unsecured, short-term corporate debt issued at a discount, with a maturity of 270 days or less so it is exempt from full SEC registration.

Halloway Industries needs seasonal working capital. In one month it draws on a privately negotiated bank line of credit; in the next it sells short-term unsecured notes to a group of institutional buyers. Which statement about these two borrowings is correct?

1. A.Both create securities, because in each case Halloway promises to repay borrowed money with interest.Wrong. A promise to repay is common to every loan, and treating it as sufficient would make every car loan and mortgage a security.
2. B.Neither creates a security, because both borrowings fund ordinary commercial operations.Wrong. Purpose alone does not decide it, since notes distributed to a body of buyers are securities regardless of what the cash funds.
3. C.The bank line of credit creates a security; the notes sold to institutional buyers do not.Wrong. This inverts the analysis, because a privately negotiated bank facility is the paradigm case of commercial lending.
4. D.The notes sold to institutional buyers are securities; the bank line of credit is not.Correct. Notes offered to a body of buyers are securities, while a one-on-one negotiated bank facility is commercial lending.

Why: Notes are named in the statutory definition, but not every piece of paper evidencing a debt is a security, and ordinary commercial and consumer lending sits outside it. What separates them is whether the instrument is distributed to a body of buyers looking to it as an investment and whether another regulatory scheme already protects them. Halloway's commercial paper is offered to a group of buyers relying on Halloway's credit for a return, so it is a security, though its short maturity may exempt the offering from registration. The bank line is negotiated one-on-one with a supervised lender that underwrites the credit itself, which makes it a loan rather than a security.