Assignment: Commercial paper borrowing has continued to decline, with October 20

Question

Assignment:

Commercial paper borrowing has continued to decline, with October 2016 reports listing borrowing at the lowest level in over a decade. Please read more information here: https://www.reuters.com/article/usa-commercialpaper/u-s-commercial-paper-market-shrinks-to-smallest-in-16-years-idUSL2N1CC0SX (Links to an external site.)Links to an external site.    

The article ends with a statement: “‘the Reserve Primary Fund’s share value fell below $1 or “broke the buck” shortly after the collapse of Lehman Brothers during the global financial crisis.”

What do you think will happen with the prime rate? If anticipating a change, how quickly do you think this will affect commercial paper borrowing?

Explanation / Answer

Commercial Paper is an unsecured,short term debt instrument issued by a corporation, typically for the financing of account receivables,inventories and meeting short term liabilities. Financial institutions use proceeds from these short term debt tofund their trades.

The regular decline in the commercial paper borrowing by prime funds have increased the short term borrowing costs.

As the Reserve primary fund's share value fell below $1,it is not able to cover its operating expenses and thus broke the buck.

The prime rate will rise in the future making the borrowings expensive as the financial institutions have got funds crunch and thus rise the prime rate.

As a result, the commercial paper borrowings will again gain the momentum and people will move towards commercialpapers looking at the high prime rate of loan amount.

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