Difference Between Certificate of Deposit (CD) and Commercial Paper

Certificate of Deposit (CD) vs Commercial Paper
 

Certificates of deposit and commercial papers are both instruments used in the money market for different financial purposes. Which money market instrument is to be issued depends on the purpose for which the funds are required, with a distinction between instruments issued by private organizations, and those issued by the governments for treasury purposes. These financial instruments are quite popular among investors who wish to keep their funds in safe investments. The following article provides a clear description of each, clearly outlining their differences and uses.

What is a Certificate of Deposit (CD)?

A certificate of deposit (CD) is a document issued by the bank to an investor who chooses to deposit his funds in the bank for a specific amount of time. A certificate of deposit can also be referred to as a promissory note issued by a bank. One feature of the CD is that once the money has been deposited for a period of time the depositor cannot withdraw the funds without incurring a penalty for early withdrawal. Since funds cannot be withdrawn as pleased, the interest paid to the depositor of a CD is higher than for a savings account. Once the CD matures, at the end of the specified term of holding the funds are repaid to the depositor alongside the interest calculated for the period. CDs issued by banks can be negotiable or non-negotiable. A negotiable CD allows the holder to sell it on the money market before maturity. A non-negotiable CD mandates the depositor hold the funds till maturity or incur a penalty for early withdrawal.

What is a Commercial Paper?

Commercial paper is a short term money market instrument that matures within a period of 270 days. Commercial papers are used as a means of raising funds, sometimes used instead of a bank loan, and are usually preferred over a bank loan since large amounts of funds can be raised within a short period of time. Commercial papers are not backed by collateral and, therefore, only creditworthy institutions with high debt ratings can issue them to obtain funds at a lower cost of interest. If the organization does not have a very attractive debt rating they may have to offer a high interest rate that covers investment risk, to attract investors to invest. An advantage to the issuer of a commercial paper is that since the instrument has a very short maturity it does not require a registration with the Securities and Exchange Commission (SEC), which makes it much less complicated and a cheaper form of obtaining finance.

Comparison between Certificate of Deposit (CD) and Commercial Paper

CDs and commercial papers are both forms of money market instruments and are issued in the money markets by organizations that wish to raise funds, and are traded by investors who wish to profit from the interest rate fluctuations. However, there are many differences between these two forms of instruments, since CDs are issued as a proof of an investment of funds in the bank by a depositor while commercial papers are issued to an investor as a proof of purchase of the issuer’s debt (purchasing debt means providing funds like a bank gives out a loan). The main difference between the two forms of instruments is the time period of maturity of the two. While a CD is usually for a longer term, a promissory note is for a shorter period. The issuance of a CD, owing to this difference in maturity, entails higher responsibility on the issuer’s part than for a promissory note; the CD is insured by the Federal Deposit Insurance Corporation (FDIC) so that the depositor will be reimbursed in the incident that the bank fails to repay the deposit.