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Unformatted text preview: ber, led
Standard & Poor’s to downgrade
senior unsecured debt and shortterm debt for both GM and its
GMAC financing arm. This
increased GM’s cost of issuing
commercial paper for its shortterm financing requirements and
also pushed up its longer-term
financing costs at a time when its
overall financing needs were on
Sources: Adapted from Sholnn Freeman and
Gregory White, “GM to Extend 0% Financing
Deal to Jan. 2,” Wall Street Journal (November 13, 2001), p. A2; Micheline Maynard,
“Auto Sales Dip Slightly from 2000 Record,”
San Diego Union-Tribune (January 4, 2002),
pp. C1, C3; Jonathan Stempel, “S&P Cuts
Ford, General Motors Ratings,” Reuters
Business Report (October 15, 2001); and Gregory White, “GM’s 0% Finance Plan Is Good
for Economy, Risky for the Company,” Wall
Street Journal (October 30, 2001), pp. A1, A8. Interest on Commercial Paper
Commercial paper is sold at a discount from its par, or face, value. The interest
paid by the issuer of commercial paper is determined by the size of the discount
and the length of time to maturity. The actual interest earned by the purchaser is
determined by certain calculations, illustrated by the following example.
EXAMPLE Bertram Corporation, a large shipbuilder, has just issued $1 million worth of
commercial paper that has a 90-day maturity and sells for $980,000. At the end of
90 days, the purchaser of this paper will receive $1 million for its $980,000 investment. The interest paid on the financing is therefore $20,000 on a principal of
$980,000. The effective 90-day rate on the paper is 2.04% ($20,000/$980,000).
Assuming that the paper is rolled over each 90 days throughout the year, the effective annual rate for Bertram’s commercial paper, found by using Equation 4.23, is
8.41% [(1 0.0204)4 1].
An interesting characteristic of commercial paper is that its interest cost is
normally 2 to 4 percent below the prime rate. In other words, firms are able to 648 PART 5 Short-Term Financial Decisions Hint Commercial paper is
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