Commercial Paper Presentation

What are the different segments (or supply side) of the commercial paper market?

Commercial paper is a short-term debt instrument issued by large corporations in order to raise capital cheaply at short-term interest rates. The three types are asset-backed, financial, and corporate.

Who are the major investors (or demand side) of the commercial paper market?

For investors, commercial paper offers returns slightly higher than treasury bills in exchange for taking on minimal credit risk The main investors are money market funds and mutual funds.

Briefly explain the concept of rollover risk faced by issuers of asset backed commercial paper?

Rollover risk arises when an issuer has a mismatch of assets and liablities. The liabilities consist of short term asset backed commercial paper. When the commercial paper needs to be repaid (because they are short term), the bank has to refinance by issuing more commercial paper. However, if investors decide not to purchase the new commercial paper, they are left with large obligations which can put them in default.

What were the risks faced by the real economy and the policy responses of the Federal Reserve to save this market.

The Fed jumped in to stablize the market for financial and asset-backed commercial paper. Many financial intermediaries used commercial paper to finance their lending activities and increasing the difficulty in issuing commercial paper sharply reduced their ability to provide loans.

Briefly explain the reasons behind the collapse of the asset backed commercial paper market.

This was triggered by the crisis in the subprime mortgage market. Bear Sterns hedge funds that invested in subprime mortgages began filing for bankruptcy as delinquinces in subprime mortgages rose. Then, investors in asset-backed commercial paper became concerned that the collateral backing asset-backed commercial paper might be of a lower quality than they initially thought, and decided to not refinance their maturing commercial paper. Because of credit guarantees, sponsoring FIs had to provide liquidity to pay off maturing asset-backed commericial paper. This obligation raised concerns about counterparty risk among banks, and cause interbank lending rates to shoot upwards. The lower demand for commercial paper caused issuers to issue more commercial paper with shorter maturity. Money market funds pulled out their investments in commercial paper.