|Methods and techniques|
Direct paper - are non-public, short-term securities issued by non-financial business entities to finance operations. The main functions of short-term debt securities are to cover the demand for operational capital by issuing unsecured securities with a maturity of no more than one year (S. Heffernan, 2005, p. 125).
Properties of direct paper
Direct paper exhibits certain advantages and properties regardless of the legal structure used by individual companies. Direct paper is issued in the form of dematerialized discount instruments, so they take the form of an electronic-account record and are made available on the primary market below their face value. Placed instruments are on the market in the form of bearer securities and have a high unit denomination. Summing up, short-term debt securities are offered to institutional investors, insurance companies and investment funds on the primary market. A special feature of direct paper is the fact that they are unsecured money market instruments. This means that the guarantee of securing debtors' liabilities is the financial condition, ability and profit generation and its liquidity. In the mature direct paper markets, the debt-back guarantee is the rating of the enterprise that finances its business using these debt securities. However, it is an instrument of marginal importance. Therefore, the market is also introduced to safeguard investors' interests in the form of a surety, credit line, collateral in kind (mortgage) and in the form of a surety. The direct paper characteristics discussed above point to the fact that it is an instrument for a limited group of issuers with a reliable position on the market and financial condition (S. Frederic, A. Serletis, 2011, p. 514-515).
Types of direct paper emissions
The direct paper issue structure adopts two model solutions (J. Paul, P. Suresh, 2018, p. 44):
- Direct issue, which consists in the fact that the entity issuing short-term debt securities also acts as an issue agent that deals with the organization and operation of the program
- Indirect emission, which is based on a financing structure that includes the issuing agent (financial intermediary).
In practice, the vast majority of short-term debt securities issued are adopted by the second model, which is indirect. The reason is the low cost of raising capital and higher emission efficiency. It is worth emphasizing the fact that direct issuing is mainly decided by American financial institutions.
Stages of direct paper issue
The indirect issue of direct paper enterprises can be presented in four stages (S. Frederic, A. Serletis, 2011, pp. 543-544):
- Stage one - consists in concluding a contract with an issue agent, that is a bank or a brokerage office for the provision of services within the organization and financing strategy. The Bank in the contract undertakes to issue debt securities, but it is also possible to conclude additional contracts, under which the broker may also act as an issuer and payment agent. In the first stage, an emission order is submitted along with a description of its parameters and program.
- The second stage - consists in concluding by the agent the issuance of optional contracts with external entities whose subject matter are the instruments that guarantee the program's liquidity and the commissioning of the rating. On the basis of the above-mentioned activities, an information note is prepared, which presents the most important information regarding the issuer and issued financial values.
- The third stage consists in offering the issue of instruments by an agent to a selected group of investors. In addition, this agent places market values.
- Fourth stage - in this stage there is a cash flow from the money market, ie from investors to the source of demand, namely the issuer. The costs of the direct paper offer can be divided into the costs of preparing the broadcast program, which include, among others commission for the agent, the costs of assigning the rating and the costs invested in the funds, among others discounting costs, stamp duty, or costs related to agent service.
- Frederic S., Serletis A., (2011), The economics of money, banking and financial markets, Pearson, United States.
- Heffernan S., (2005), Modern Banking, John Wiley and Sons, United States.
- Paul J., Suresh P., (2018), Management of Banking and financial Services, Pearson India Education Services.
- Remolona E.M., Wulfekuhler K.C., (1992) Finance Companies, Bank Competition, and Niche Market, FRBNY, New York.
Author: Karolina Kurcz