Direct paper

Direct paper
See also
Creation of money Capital Base Equity instrument Financial resources Musharaka Appropriation of retained earnings Banking book Consumer loan Credit Facility

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.

Examples of Direct paper

• Commercial paper: Commercial paper is a type of unsecured, negotiable promissory note issued by a corporation, typically for financing its short-term credit needs. It typically has a maturity of up to 270 days, and is issued directly by the company in the form of physical certificates or through a digital platform.
• Asset-backed securities: Asset-backed securities (ABS) are a type of direct paper that are created by pooling various types of loans and other assets, such as car loans, credit card debt, and student loans. The cash flows generated by the underlying assets are used to pay the principal and interest of the ABS.
• Banker's acceptances: Banker's acceptances are a type of direct paper that are issued by banks and accepted by the issuing bank. They are typically used by companies to finance foreign trade transactions and are generally short-term investments with maturities of up to 180 days.

Advantages of Direct paper

Direct paper can be an advantageous short-term financing solution for businesses with a number of advantages, including:

• A short-term commitment, with maturities of up to one year, allowing businesses to access capital quickly and efficiently.
• The cost of the capital is typically lower than bank debt, since it is not secured by collateral.
• The non-financial issuing entity does not need to provide additional financial information to investors, making the process of issuing the securities more efficient.
• Direct paper can be used to attract new investors to the business, increasing the liquidity and visibility of the issuing entity.
• Direct paper can also be used to restructure existing debts, providing more flexibility to the issuing entity.

Limitations of Direct paper

Direct paper has certain limitations that should be taken into account when choosing whether to use it for financing operations. These include:

• A short maturity period of no more than one year, which may be insufficient for companies that need long-term financing.
• Unsecured securities, meaning that creditors have no legal rights to the assets of the issuing company.
• Limited availability, since only non-financial business entities are eligible to issue direct paper.
• Difficulties in accessing the capital markets, due to the lack of a credit rating or track record in issuing securities.
• High volatility in the prices of direct paper, making them more costly to issue than other forms of financing.
• Low liquidity, as direct paper is not as widely traded as other forms of debt securities.

Other approaches related to Direct paper

Other than issuing direct paper, there are several other approaches to finance operations.

• Equity financing: This approach involves the issuance of common or preferred shares in exchange for cash or other assets. Equity financing helps businesses to raise capital and build a larger shareholder base.
• Venture capital: This approach involves private investment in promising start-up companies. Venture capital firms provide the necessary funding for these companies in exchange for partial ownership and potential returns.
• Debt financing: This approach involves the issuance of bonds or other debt instruments in exchange for capital. Debt financing is often used by businesses to pay for large operating expenses or capital expenditures.
• Asset-based financing: This approach involves the use of assets such as real estate, inventory, or equipment as collateral for a loan. Asset-based financing can provide businesses with access to capital without the need for equity or debt financing.

In conclusion, the primary approach to finance operations is through the issuance of direct paper. Other approaches to finance operations include equity financing, venture capital, debt financing, and asset-based financing. Each of these approaches has its own benefits and risks and should be carefully evaluated before making any decisions.

References

• 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