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What are the advantages of commercial paper in comparison with bank borrowing at the prime rate? What is a disadvantage?

Short Answer

Expert verified

Commercial paper is advantageous as it has a low-interest rate as compared to borrowing from banks. The commercial paper is an unsecured source so it can be disadvantageous.

Step by step solution

01

Meaning of commercial paper

The commercial paper is a money market instrument used as a promissory note. This is a short-term instrument and helps in diversifying the short-term borrowings of the corporate borrowers.

02

Advantage of commercial paper in comparison to borrowing at the prime rate

Commercial paper is generally issued at a low-interest rate as compared to the prime rate. There is also no compensating bank requirement but the borrower is required to maintain a credit line at the bank.

03

Disadvantage of commercial paper in comparison to borrowing at the prime rate

The disadvantage is that the commercial paper is an uncertain source of funds, there is no loyalty factor between the bank and customer, and funds may not be available when the market gets tight.

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