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Short-term paper refers to investments that mature in nine months or less. Certificates of deposit with short maturities, short-term bonds, promissory notes, and Treasury bills are all considered to be short-term paper. These types of investments can be issued by governments, financial institutions, or corporations.
Short-term paper tends to be low in risk and high in liquidity. Because the term is nine months or less, and often as little as 90 days, there is little risk that the interest rate will increase drastically during that time which would make other investments more attractive. Likewise, the short-time horizon means that the investor will get back his investment, with interest, within a relatively short period of time.
Many companies, financial and government institutions rely on short-term paper in order to finance most of their daily operations. Due to the good credit of these organizations, they usually have no problem issuing and redeeming these notes in order to meet their requirements. During the credit crunch of 2008 and 2009, however, many organizations were unable to issue the short-term paper they needed in order to operate, and the U.S. government had to assist them with a bailout. This credit crisis forced some companies out of business, and made others curtail their businesses until short-term credit was made more available.
Sometimes the issuing company uses some of its assets as collateral for short-term paper transactions. This is referred to as asset-backed commercial paper. Accounts receivable are commonly used as collateral for asset-backed commercial paper. When a company sells its accounts receivable to a bank, the bank can then issue asset-backed commercial paper. After 90 to 180 days, when the company has collected its receivables, it buys back the matured paper plus interest. If a company has a credit report that is less than stellar, it may issue asset-backed commercial paper in order to raise money in the short term.
Short-term paper is typically purchased at a discount, so that at maturity, the investor receives the face amount of the bond. The difference between the price the investor paid for the bond and the price at which it is redeemed, or the face amount, represents the return on investment. Since it is a fixed income investment, and often backed by assets of the issuing institution, it is relatively safe. An investment bank that handles a significant amount of short-term paper may be referred to as a paper dealer.
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