Commercial paper is quoted on a bank discount basis, not a yield basis. The rate you see from a dealer is the discount from face value expressed as a percentage of that face value, not the return on the cash you actually put up. Because the discount quote understates what your money earns, most investors convert it to a bond equivalent yield before comparing commercial paper against Treasury bills, notes, or other short-term instruments. With roughly $1.4 trillion outstanding in early 2026, the difference matters across any sizeable portfolio.1Federal Reserve Bank of St. Louis. Commercial Paper Outstanding (DTBSPCKM)
How the Discount Quote Works
Commercial paper pays no coupon. You buy it below face value and receive the full face amount at maturity. The gap between purchase price and face value is your entire return, and the quoted discount rate describes that gap relative to the face value.
The formula is: face value multiplied by the quoted discount rate, multiplied by days to maturity divided by 360. That produces the dollar discount, which is subtracted from face value to give the purchase price.
A worked example makes the mechanics concrete. Take a $1,000,000 note quoted at a 4% discount with 90 days to maturity. The dollar discount is $1,000,000 × 0.04 × (90 ÷ 360), or $10,000. You pay $990,000 and collect $1,000,000 three months later. The quoted 4% describes that $10,000 against the $1,000,000 face value, even though only $990,000 of your money was ever at work. That mismatch is the reason the discount rate understates your real return.
Commercial paper typically sells in minimum denominations of $10,000, though some programs set the floor at $5,000. Most trades are far larger, with $100,000 round lots common among money market funds, insurers, and corporate treasuries.2eCFR. 12 CFR 250.221 – Issuance and Sale of Short-Term Debt Obligations by Bank Holding Companies
The 360-Day Year
Money market quotes use a 360-day year rather than the actual 365 or 366 calendar days. The convention dates to an era when twelve thirty-day months made hand calculation easier, and it stuck. When a dealer quotes a discount rate, the fraction of the year in the pricing formula is always days to maturity divided by 360.
This does real work in the numbers. Using 360 instead of 365 slightly inflates the dollar discount for any given quoted rate, so you pay a little less than an actual-day count would produce. It also means that once you annualize your return on the actual calendar, the effective yield sits above the quoted discount for two reasons at once: the denominator changes from face value to purchase price, and the year stretches from 360 to 365. Treasury securities, by contrast, are often quoted on an actual/365 basis, so a straight comparison of headline rates is misleading before any conversion.
Converting the Quote to Bond Equivalent Yield
The bond equivalent yield restates the return based on what you actually invested and annualizes it over a real 365-day year. The formula is:
Bond Equivalent Yield = (Face Value − Purchase Price) ÷ Purchase Price × (365 ÷ Days to Maturity)
Run the earlier example through it. The $1,000,000 note bought for $990,000 with 90 days remaining gives ($10,000 ÷ $990,000) × (365 ÷ 90), or roughly 4.10%. The quote was 4%. Your money is earning 4.10% on an annualized basis. The gap widens as rates rise and as maturities lengthen, because the purchase price drops further below face value and the 365/360 adjustment compounds on top.
The conversion is standard practice for professional portfolio managers. SEC Rule 2a-7, which governs money market funds, requires ongoing assessment of portfolio value, and managers need yield figures that reflect actual returns on invested capital rather than discount quotes that obscure them.3eCFR. 17 CFR 270.2a-7 – Money Market Funds
Why the Distinction Changes Real Decisions
An investor comparing a 5% discount quote on 180-day commercial paper against a 5% yield on a six-month Treasury note is not comparing like with like. The commercial paper actually returns more than 5% on invested capital once you convert to bond equivalent yield, because the discount uses face value as the denominator and a 360-day year. Skipping the conversion across a large portfolio compounds into meaningful mispricing.
The dynamic runs the other way for issuers. A corporation looking at a 5% discount quote might read that as borrowing at 5%, but the effective cost of funds is slightly higher when measured against the cash actually received. Treasury departments track that gap when weighing commercial paper against a revolving credit facility or another short-term funding source.
The conversion matters for inflation comparisons too. A 4.8% discount quote against 4.5% headline inflation looks thin as a real return. Convert to bond equivalent yield and the picture improves, though not by much. Either way, an investor who reads the discount quote as a yield is misreading the risk-return tradeoff in what is supposed to be one of the safest corners of the fixed-income market.
How the Discount Is Taxed
One point worth flagging, because the pricing convention and the tax treatment are separate questions. The discount you earn on commercial paper is taxed as ordinary income, not as a capital gain. Commercial paper falls under the IRS rules for short-term obligations because its maturity is one year or less. If you hold to maturity, the difference between your purchase price and the face value is ordinary interest income in the year you receive payment.4Internal Revenue Service. Publication 550 (2025), Investment Income and Expenses
Some holders must recognize the discount as it accrues rather than at maturity, including banks, regulated investment companies, accrual-method taxpayers, and anyone holding the paper primarily for resale in the ordinary course of business.5Office of the Law Revision Counsel. 26 USC 1281 – Current Inclusion in Income of Discount on Certain Short-Term Obligations Short-term obligations of one year or less are specifically excluded from the general original issue discount rules that apply to longer-term bonds.6Office of the Law Revision Counsel. 26 USC 1272 – Current Inclusion in Income of Original Issue Discount Section 1281 governs instead. The practical effect is similar for most holders, but the statutory path differs, and getting the reporting wrong can trigger penalties. Most individual investors never confront this directly because they hold commercial paper indirectly through a money market fund that handles accrual and reports the income on a 1099.