Dear Dr. Don,
What’s the advantage of investing in commercial paper as opposed to a short-term bond or a bank CD? Also, am I better off (buying) secured or unsecured bonds? Why?
— Steve Short-Time
Commercial paper is a money market security, meaning it is a debt security with a final maturity of a year or less. Actually, commercial paper has a final maturity of no more than 270 days. Commercial paper is an unsecured promissory note issued by a company to finance its operating expenses or current assets.
Corporate bonds are capital market securities with final maturities longer than a year. Bonds may be secured or unsecured. Secured debt is backed by collateral. Unsecured debt doesn’t have any collateral pledged against the loan.
Secured debt is considered less risky than unsecured debt because of the collateral. To draw a parallel in consumer finance, mortgages and auto loans are secured while credit card debt is unsecured. You’d expect to earn a higher yield on unsecured debt than secured debt because of the additional risk you’re taking on as an investor.
The commercial paper market is recovering from liquidity and credit quality issues exhibited in the last quarter of 2008. The Federal Reserve Board tracks these rates and releases them daily with a one-business-day lag. You can find the rates at the Fed’s Web site.
You can shop CD rates both in your market and nationwide using Bankrate’s “Rate Search” function. FDIC-insured CDs are backed by the insurance fund and the full faith and credit of the U.S. government.
When deciding where to invest short-term, you have to strike a balance between liquidity, safety, convenience and yield. Chasing yield in the commercial paper market or corporate short-term bonds may give you a pick-up in yield over a short-term CD. But that increase in yield is, in part, compensating you for the additional risk you’re taking on in the investment. You have to decide if you’re being adequately compensated for that risk.