What is Commodity Paper?
Commodity paper is a loan or advance for which raw materials owned by the borrower act as collateral. The term paper alludes to the contract, which is for the most part a promissory note. For certain commodities the collateral might be involved grading certificates, warehouse receipts or bills of lading.
Understanding Commodity Paper
Commodity paper is like a mortgage agreement or a vehicle loan. With a [secured debt,](/secureddebt) the collateral swore gives the lender confirmations they have some recourse should the borrower default or fail to satisfy the terms of the contract. Though a home or other real estate gets a mortgage, on account of a loan including commodity paper, the collateral is as commodities.
Commodities are raw materials or production goods, like oil, grain, gold, copper, coffee, cocoa, amble, cotton, wheat, corn, sugar, and natural gas. By the idea of the products and materials included, commodities may not be promptly accessible at a specific location, and consequently it might at times be troublesome, on the off chance that certainly feasible, to deliver them to give as collateral.
Giving Proof to Commodity Paper
It is generally excessive for the goods which act as collateral to be available, so the length of verification of their circumstance can be gotten to should the need emerge. The lender won't claim the commodities except if the borrower defaults.
Frequently, the lender will need to affirm that the assets getting the loan exist in the quality and quantity required. Contingent upon the commodity backing the note, proof might exist in a few unique formats. Products, for example, grains and oil might utilize a grading certificate. A grading certificate is a document issued by overseers or an approved grading panel that formally means the quality of a commodity. Commodities, for example, live steers or hoards might require proof of a delivery order or a bill of lading. Gold or other precious metals stored in a vault might require a vault or warehouse receipt.
An Example of Lender Risks
The failure to physically claim collateral or if nothing else outwardly assess and affirm its presence can introduce an element of risk to the lender, particularly in the event that the borrower is dishonest or plans to beguile the lender.
Commodity paper was at the center of a remarkable occurrence known as the Salad Oil Scandal. In 1963, the owner of Allied Crude Vegetable Oil utilized doctored documents to expand inventory levels and afterward borrowed against the fraudulent receipts. At the time the fraud was found, the company had just 134 million pounds of oil in its storage tanks, compared with 937 million pounds that appeared on its receipts. The fraud cost banks an estimated $200 million (in 1960s dollars).
Trading in Commodities
The most common methods of trading commodities include:
- Futures are financial contracts committing the buyer to purchase a asset, or the seller to sell an asset, at a predetermined future date and price.
- Options offer the buyer the right, however not the obligation, to call or put the underlying asset at a settled upon price during a specific period.
- Exchange-traded funds are liquid marketable securities that track a commodity or a commodity basket and trade like stocks on an exchange.
- Commodity paper is like a mortgage agreement or a vehicle loan, however the loan manages commodities.
- Commodity paper is a loan or advance for which raw materials owned by the borrower act as collateral.
- It is generally excessive for the goods to be available, as long verification of their circumstance can be gotten to should the need emerge.