Certificates of Deposit (CDs) and Commercial Paper (CP)

The biggest difference between the two is the issuing entity.

A certificate of deposit (CD) is a 'transferable fixed-deposit certificate' issued by a bank. Think of it as a fixed deposit with a 'can be sold to someone else' feature added. It's issued in bearer form and can be handed to a third party before maturity.

Commercial paper (CP) is a short-term bond in the form of a note that companies issue to raise short-term funds. In effect, the company borrows money directly from the market without going through a bank.

In a word, a CD is 'a bank's debt' and CP is 'a company's debt.' This difference determines the size of the risk we'll see later.

CDs and CP are both short-term products. CDs are issued for at least 30 days (usually 30 days to 1 year, with 91-day being common), and CP is also usually issued within 1 year.

Both products use the 'discount issuance' method. Discount issuance is a structure where you buy below the face amount and receive the face amount at maturity.

For example, suppose you buy for about $71,800—with interest taken off—a piece of CP that pays about $74,000 at maturity. When maturity comes you receive about $74,000, so that difference of about $2,200 is effectively the interest.

In other words, you don't receive interest separately; the return arises through 'buying cheap and getting the face value back.'

This is the crux. CDs and CP differ greatly in safety.

Because a CD is issued by a bank, it relies on the bank's credit. It's relatively stable, but even so, a CD is classified not as a deposit but as a 'financial investment product' and is not covered by deposit insurance. You mustn't confuse this with a bank fixed deposit.

CP carries more risk. It's usually unsecured (no collateral) and depends solely on the issuing company's credit. On top of that, CP has weak obligations for submitting financial statements, disclosure, and external audit, so investors often find it hard to know the company's actual condition.

That's why CP tends to pay higher interest (return) than a CD, but that higher rate is 'compensation for greater credit risk.' High return can be a signal that the risk of not being paid back is correspondingly large.

The risk of CP is not theory; it has actually erupted before.

The 2013 Tongyang Group case is representative. Already having lost the ability to repay, it sold about ₩1.3 trillion worth of affiliate CP and corporate bonds to roughly 40,000 individual investors through securities firms, and as the group collapsed, many investors suffered large losses. Controversies over accounting fraud and mis-selling piled on as well.

There was also the 2011 LIG Engineering & Construction CP fraudulent-issuance case. It issued CP while hiding insolvency ahead of court receivership, and investors who bought it were harmed.

The lesson of these cases is clear. Treating CP as a safe deposit by looking only at 'high interest' is dangerous. If you don't check who the issuing entity is and what its credit is like, you can lose your entire principal.