PROMISSORY NOTE

A promissory note is a written agreement from one party to another that promises the payment of a specific amount of money on a specified date. A promissory note is an alternative means of obtaining credit that is not widely used; it is more common to obtain business credit through an open account with a line of credit. A promissory note may be negotiable, so that the holder can sell or transfer the note to another party by endorsing it. In such cases the transferred note would usually be discounted somewhat from its face value.

Promissory notes of large corporations are also known as commercial paper. Commercial paper offers large corporations an alternative means of obtaining short-term financing. Most commercial paper is due in two to six months. It is usually sold to other business firms, insurance companies, pension funds, and banks. There is also an open market of commercial paper dealers. These kinds of promissory notes are usually issued in denominations of at least $1 million. The interest paid on prime commercial paper is usually slightly lower than that charged for prime business loans, so large firms with good credit ratings often choose to issue commercial paper rather than obtain a bank loan or use their line of credit.

The use of commercial paper on the open market is generally limited to large firms that are good credit risks. Purchasers often require that the issuer have enough open credit to back the note. Otherwise, payment of the promissory note may be dependent on the issuer having excess funds on hand. It is possible for a company's promissory notes to go into default if the company declares bankruptcy.