Commodity paper is the contract for a loan which is secured by collateral in the form of a commodity held in a warehouse or in transit.
This is basically a form of warehouse financing, where the inventory in storage is verified and the changing level of inventory insures a larger or smaller line of credit from the lender. In this arrangement, however, there is one agreed-upon loan and collateral amount.
Commodity paper is a contract guaranteeing the repayment of a loan using commodities which are in the possession of the borrower. Warehouse receipts or bills of lading (for inventory in transit) serve as proof that the commodity inventory exists, and the lender has a lien on the commodities until the loan is repaid.
A warehouse financing arrangement, by contrast, requires that the lender or a third party inventory manager has possession or oversight of the inventory until the loan is repaid. One of the main ways that commodity paper is used is to give agricultural producers (farmers) some liquidity between the time they harvest the goods and when they sell them.
Agricultural commodities which are seasonal and have a certain shelf-life are called soft commodities.
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