Difficulty: Easy

Average Score: 81%

Which of the following phrases defines a commercial paper?

Rationale

A short-term debt security issued by large banks and corporations.

Commercial paper is an unsecured, short-term debt instrument used primarily for the financing of accounts receivable, inventories, and meeting short-term liabilities. It is typically issued by corporations and large banks to obtain funds quickly and efficiently.

A (A short-term debt security issued by large banks and corporations) CORRECT

This is the correct definition of commercial paper, which is a crucial tool for corporations and financial institutions to manage short-term funding needs. The instruments are typically issued at a discount and mature in a few days to up to 270 days.

B (A long-term money order issued by a central bank) YOUR ANSWER

This choice incorrectly describes a long-term instrument. Commercial paper is specifically a short-term security, and money orders are not classified as debt instruments. Central banks do not issue commercial paper; they may issue other types of securities or instruments, but not in this context.

C (A short-term money draft issued by Federal Reserve Bank) YOUR ANSWER

This option mischaracterizes commercial paper as a money draft. While it is short-term, commercial paper is not issued by the Federal Reserve Bank; rather, it is issued directly by corporations and large banks. The Federal Reserve may influence interest rates but does not issue commercial paper.

D (A long-term bond issued by state banks and credit unions) YOUR ANSWER

This choice is incorrect because it describes a long-term bond, which is fundamentally different from commercial paper. Bonds are typically long-term instruments with maturities greater than one year, whereas commercial paper is specifically designed for short-term financing needs.

Conclusion

Commercial paper serves as a vital financial instrument for corporations and financial institutions, enabling swift access to short-term funding. By understanding its definition as a short-term debt security, one can distinguish it from other financial instruments like long-term bonds and money orders, which serve different purposes and have varying characteristics.

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