A treasurer at a mid-cap firm needs $200 million by Friday to fund payroll and inventory. A bank needs $5 billion overnight to balance its reserves. Both reach for short-term funding, but they reach for different instruments, and the exam tests whether you know which lever fits which hand.
Non-financial corporations meet working capital needs through a stack of instruments ordered by cost and flexibility.
- Commercial paper (CP). Unsecured promissory notes, typically 1 to 270 days, issued at a discount by highly rated firms.
- Committed lines of credit (revolvers). Bank promises to lend up to a limit. A commitment fee is paid on the unused portion. Reliable in stress.
- Uncommitted lines. Bank may lend at its discretion. Cheaper but not bankable in a crisis.
- Trade finance. Letters of credit, banker's acceptances, factoring of receivables, and supply-chain finance. Useful when goods are in transit.
- Secured loans. Inventory or receivables pledged as collateral when unsecured access is closed.
KEY: Commercial paper is unsecured and short-dated. The investor relies on the issuer's credit, not on collateral. That is why only strong issuers can access the CP market.
Common mistakes
- Calling repo "unsecured short-term funding." Repo is secured by definition. The collateral transfer is what makes the rate lower than fed funds. Trap: confusing repo with interbank lending.
- Treating commercial paper as available to any issuer. CP is effectively limited to investment-grade firms. A high-yield issuer relies on revolvers, secured loans, and bond markets, not CP.
- Confusing haircut direction. A 2% haircut means the lender advances 98 cents on the dollar of collateral value. Trap: computing cash = market value × haircut (gives $2 million on $100 million collateral).
Bottom line
- Corporations use commercial paper, lines of credit, and trade finance. Financial institutions add deposits, interbank loans, CDs, central bank facilities, and repos
- Commercial paper is unsecured and short-dated, effectively reserved for investment-grade issuers; high-yield firms rely on revolvers, secured loans, and bonds instead
- Committed revolvers charge commitment fees on undrawn balances and act as crisis liquidity backstops
- Repo = sell a security now, repurchase later at a higher price. The difference is the repo rate (the price differential annualized). It is economically a collateralized loan
Exam shortcut
Match the funder to the toolkit: corporate → CP, revolver, trade finance; bank/dealer → add deposits, interbank, CDs, repo. For repo cash flows, always compute cash = market value × (1 − haircut), then add interest = cash × rate × days/360. For investment-grade vs. high-yield, remember the IG-HY shift: light covenants to incurrence covenants, senior unsecured to secured/subordinated, make-whole to hard call protection.
The full lesson (about 1,858 words, 12 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- markets for corporate issuers
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