Commercial papers and other money market securities are known for their high liquidity and lower risk...
Commercial papers and other money market securities are known for their high liquidity and lower risk however during the financial crisis of 2007 through 2009 commercial papers experience large decline. Explain the main reasons for commercial paper market collapse and how the intervention of the fed rescued this Market
Homework Answers
Commercial paper is used to raise money using short term debt instrument by large company. It pays higher interest rate than US treasury bills for taking low credit risk.
During 2007, most of the commercial paper in US was issued by financial sector. From 2007 itself financial sector showed sign of subprime mortgage crisis, banks started filing for bankruptcy and announcing losses. Given that commercial paper issued was colletaterized with similar assets which were hit by crisis, the asset backed commercial paper market fell drastically. The perception that they are of high liquidity and low risk changed as colletaterized assets were becoming illiquid.
Rescuing commercial paper market
1. US government announced deposit insurance for investment in money market but market did not stabilize.
2. Fed provided loan to commercial bank to buy commercial papers and if issuer of CP defaulted federal Bank would buy such CP.
3. Fed intervened using repurchase agreements, large outright purchase of commercial paper directly to stop decline and thus stabilized CP market in US.
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Commercial papers and other money market securities
are known for their high liquidity and lower risk...
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