Line of Credit
Commercial paper is a lower cost alternative to a line of credit with a bank. Once a business becomes established, and builds a high credit rating, it is often cheaper to draw on a commercial paper than on a bank line of credit. Nevertheless, many companies still maintain bank lines of credit as a "backup". Banks often charge fees for the amount of the line of the credit that does not have a balance. While these fees may seem like pure profit for banks, in some cases companies in serious trouble may not be able to repay the loan resulting in a loss for the banks.
Advantage of commercial paper:
- High credit ratings fetch a lower cost of capital.
- Wide range of maturity provide more flexibility.
- It does not create any lien on asset of the company.
- Tradability of Commercial Paper provides investors with exit options.
Disadvantages of commercial paper:
- Its usage is limited to only blue chip companies.
- Issuances of Commercial Paper bring down the bank credit limits.
- A high degree of control is exercised on issue of Commercial Paper.
- Stand-by credit may become necessary
Read more about this topic: Commercial Paper
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