Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Tax-Exempt Commercial Paper

What it is:

Tax-exempt commercial paper is short-term debt for which the interest payments are tax-exempt at the federal, state or local level.

How it works (Example):

Universities are some of the most common issuers of tax-exempt commercial paper. For example, let's say University XYZ needs to borrow money for, say, 90 days to finish construction on a new basketball arena. The university obtains permission from the federal government and from the government of the state in which it exists to issue $2 million of tax-exempt commercial paper. This permission essentially allows buyers of the debt to avoid paying income tax on the interest payments from the commercial paper.

Because the interest rates on tax-exempt debt are typically lower than interest rates on taxable debt, this allows University XYZ to borrow money at lower rates than it might otherwise have to pay if it borrowed the money from a bank. The commercial paper also might attract more buyers because the buyers don't have to pay taxes on the interest they receive.

Why it Matters:

Tax-exempt commercial paper is a way for governments to support the funding efforts of certain entities and institutions without having to provide cash to those entities and institutions directly. Although the government "gives up" the taxes it might otherwise collect on the interest payments that the bondholders receive, it may do so knowing that the funding that the borrowing entity obtains will serve the area's citizens in a way that is more valuable than the lost tax income.
 

Related Terms View All
  • Auction Market
    Though most of the trading is done via computer, auction markets can also be operated via...
  • Best Execution
    Let's assume you place an order to buy 100 shares of Company XYZ stock. The current quote...
  • Book-Entry Savings Bond
    Savings bonds are bonds issued by the U.S. government at face values ranging from $50 to...
  • Break-Even Point
    The basic idea behind break-even point is to calculate the point at which revenues begin...
  • Calendar Year
    If Company XYZ starts its fiscal year on January 1 and ends its fiscal year on December...