Institutional investors and money market mutual funds typically find that they can obtain a higher rate of return on their investment through the use of commercial papers or debentures.
Commercial papers and debentures are unsecured forms of debt, issued in favour of the investor by the issuing company (the “Issuer”) and act similarly to promissory notes. The commercial paper or the debenture certificate issued will indicate the principal amount, the coupon rate and the maturity date. As commercial papers and debentures are unsecured forms of debt, they are backed solely by the financial strength of the Issuer and its ability to pay the principal amount and the interest by the maturity date.
Commercial papers are suitable for shorter term financial obligations, which are typically 270 (two hundred and seventy) days or less and pay a higher rate of interest. The higher coupon rate with regards to commercial papers appeal to the investor, allowing them to obtain a higher rate of return on their investment in a shorter period of time.
Debentures are common for longer term financial obligations and typically, repayment of debentures takes place either by the Issuer paying a lump sum amount on the maturity date or by remitting amounts to the investor annually until the amount has been fully repaid by the maturity date. The coupon rate in comparison is lower and has a maturity date that is further on in the future.
As commercial papers and debentures are unsecured forms of debt, and are backed only by the financial strength of the Issuer, it is advisable for the investor to take security in the form of pledges, cessions, mortgage bonds and sureties in order to securitise their investment and mitigate their risk in the event that the Issuer defaults in its repayment.