The most important risks of a factor are:
- Counter party credit risk: risk covered debtors can be re-insured, which limit the risks of a factor. Trade receivables are a fairly low risk asset due to their short duration.
- External fraud by clients: fake invoicing, mis-directed payments, pre-invoicing, unassigned credit notes, etc. A fraud insurance policy and subjecting the client to audit could limit the risks.
- Legal, compliance, and tax risks: a large number and variety of applicable laws and regulations depending on the country.
- Operational: operational risks such as contractual disputes.
Commercial paper is a money-market security issued (sold) by large corporations to get money to meet short term debt obligations.
Analyze the commercial paper market
- There are two methods of issuing paper. The issuer can market the securities directly to a buy and hold investor such as most money market funds. Alternatively, it can sell the paper to a dealer, who then sells the paper in the market.
- Commercial paper is a lower cost alternative to a line of credit with a bank. Once a business becomes established, and builds a high credit rating, it is often cheaper to draw on a commercial paper than on a bank line of credit.