What is commercial paper? What is its maximum maturity? Why? Does it sell at a discount at face value plus interest? Extract Electrical Motors has issued $3,000,000 of commercial paper with a 30-day maturity date
If the paper sells at 99% of par value, what are the net proceeds to the firm? What is the EAR for this issue of commercial paper?
What will be an ideal response?
Answer: Commercial paper is a short-term (less than 270 days) corporate IOU designed to meet short-term cash flow needs. It is typically issued by only the most credit worthy firms. Commercial paper is issued at a discount and repays the par value with interest at maturity.
Net proceeds = (1 - discount %) × par value = (1 - .01) × $3,000,000 = $2,970,000.
EAR = (1 + rate) m -1 where the rate = interest/amount received = $30,000/$2,970,000 = 1.010101010%.
EAR = (1.010101)12 -1 = 12.82%.
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