What Is a Commercial Paper Investment &
Many investors have come to me asking about Commercial Paper. Naturally they are interested in the high yields I have spoken about, but often ask me, What the heck is Commercial Paper? For those clients that are unclear about certain investment terms, I am providing an explanation that should make things somewhat easier.
Bonds or Longer-Term Fixed Income Investments
For starters lets discuss what are known as fixed income investments. Fixed income normally refers to things like bonds, certificates of deposit or any type of investment whereby you are basically putting your money on deposit for a fixed period of time and for a fixed rate of interest. A bond is a type of fixed income investment and is in essence a loan. When you purchase a US government bond, you are loaning the government your money for a fixed time period and for a fixed rate of interest. When you purchase a corporate bond, from a company such as Pepsi or IBM, you are loaning that corporation your money in the same fashion. The term Bond is used when talking about a loan that is greater than one or two years. Most bonds are issued for five years, ten years, twenty-years and so on up to thirty years. When watching the financial news you will often hear the term US government long bond. They are talking about 30 year US government bonds, which currently pays about 5.50% at the moment.
Interest on a bond investment is normally paid every six months to the investor. At the end of the bond time period or when it matures, the principal amount is returned to the investor. As an example, if you invest $100,000 in a five-year bond at 6%, you will receive two interest checks every year, for a total of $6,000 every year that you own the bond (one check every six months for $3000). After five years, your $100,000 is returned to you. Interest on a bond is normally paid out every six months, but there are some bonds that pay interest monthly. It can be difficult to purchase long-term bonds in the Dominican Republic because many companies are fearful about borrowing money at a high rate for a long period of time. Just like investors who are looking for a mortgage, they do not want to be locked into a high interest loan if rates should go down in the future. Locking in a high rate over a long period of time is very good for the investor, but is not favorable for the entity borrowing the money.
Commercial Paper or Shorter-Term Fixed Income Investments
Commercial paper is in effect a very short-term bond, usually for any period less than one year. When talking about commercial paper investments, we are in fact discussing a type of short-term investment for 30 days, 90 days, 180 days or any time frame that is one year or less. Most investors that understand a bank certificate of deposit can relate that to a commercial paper investment. The difference of course is that you are loaning your money directly to a company and not to the bank. In essence it can be said that you are by-passing the bank because in reality banks that offer money market accounts or savings accounts are purchasing commercial paper with depositors funds and keeping the spread between what they really earn and what they pay the depositor.
Most of the commercial paper issued in the Dominican Republic is for a minimum of 90 days. Investors that make this investment are in effect loaning their money to a company for a short-term need. Interest is usually paid monthly with a commercial paper investment and at the end of the 90 days, the principal or initial investment is returned to the investor. When we work with our clients that are interested in the higher yields found in Dominican Peso Investments, we have made special arrangements with the brokers we work with so your monthly interest is automatically credited to your Dominican Peso Bank Savings Account. This way this is no hassle cashing your monthly interest check and you always have access to your money via your ATM card (which can be used worldwide at any bank machine that is a member of PLUS or CIRRUS). The commercial paper can also be registered in your name directly or if you prefer, in the name of your corporation, foundation or trust.
Why are the Rates Higher in the Dominican Republic?
Money is a commodity, like oil, silver, bananas or coffee. When it is in short supply, the price goes up. The price of money is interest rates and when it is in short supply, interest rates are higher. This is the situation in the Dominican Republic and elsewhere. Many companies either need money for a short term need or they do not want to issue longer term bonds and would prefer to continuously re-borrow every 90 days at the prevailing rate. The thinking behind this is that the company will not become locked into a very high rate on a long-term basis if the interest rates come down. Part of this business philosophy has come about because rates in the Dominican Republic have in fact come down from a high of over 30% a few years back.
Some companies do have a need for US dollars in order to trade with the United States. Since there are often not enough dollars in the banking system, companies must attract individual investors by offering a better rate of return than can be found elsewhere. An example of this can be seen with Reid & company, a 50 year-old Dominican conglomerate that happens to have a vehicle and heavy-duty equipment distributorship. They recently offered up to a 14% interest rate for 90-day commercial paper in US dollars so they could re-stock their inventory. Since the car manufacturers in Detroit want to be paid in dollars, not pesos, they needed to borrow US dollars for this purpose. Investors therefor had an opportunity to take advantage and get a good rate of return from a large and well managed local company.
The interest rates of course will change weekly, depending upon the market and demand.
How Do We Work with our Clients?
We have relationships with a number of banks, brokerage firms and mutual fund companies. In the case of commercial paper offerings in the Dominican Republic, the firms that we do business with keep us informed regarding that latest opportunities that are available, so we may in turn inform our clients. We also review these offerings and select the opportunities that offer the best rate of return with the minimum amount of risk. It is fair to say that all investors are interested in receiving a good rate of return, but also want to make sure their interest will be paid on a timely basis and that their initial investment will be returned when stated. This is our goal for our clients when reviewing potential offerings. In addition, clients know that we are here to protect their interests exclusively and have no vested interest in seeing investment money directed to one particular offering or one particular firm. There is no other firm we know of that works this way in the Dominican Republic, or attempts to protect foreign clients in this regard.
When a client wishes to make a commercial paper investment, we need to know how the ownership should be titled and what the interest payment instructions are. Commercial paper in US dollars, for example, pays monthly interest in dollars. Interest checks are drawn off a US dollar bank account in the United States, so investors have no problem cashing their checks. As an alternative, we can also arrange for the clients check to be sent to their foundation or company bank account in Panama. Regarding Dominican Peso investments, we can arrange for a local savings account in Santo Domingo with one of the local banks. This feature offers our client tremendous convenience because, by special arrangement, the brokers we work with will offer direct deposit service for monthly interest payments. When the commercial paper matures, the client can either re-new for another 90 days or request that the principal be deposited also to their savings account. For clients that live in the Dominican Republic or abroad, access is their money is always possible through their bank ATM card.
Current Interest Rates for Commercial Paper in Dominican Pesos range from 16% to 25%, depending upon the company, length of the investment and also the amount invested. Deposits of RD $ 1 Million pesos (about US$ 65,000) will always pay a higher rate than the minimum deposit of RD$ 100,000 (about US$ 6500).
Current Interest Rates for Commercial Paper in US Dollars range from 8% to 12% depending upon the company, length of the investment and also the amount invested. The higher rates are available with deposits of US$ 50,000 or more.
Interest from US Dollar Commercial Paper is tax-free in the Dominican Republic. Interest from both Dominican Peso and US Dollar Bank accounts are tax-free in the Dominican Republic. Interest from Dominican Peso Commercial Paper is tax-free depending upon the amount invested.