A promissory note, also called a "pro note", "p note" or simply "note", is a type of fixed-income debt instrument, similar to a bond, loan or even an IOU, in which one party, known as the issuer, makes a written promise to pay a certain amount of money to a specific person or entity, referred to as the noteholders, at a specific time. They have been around for many years and are common financial instruments in many countries, employed principally for short-time financing of companies.
The terms of a note are clearly spelled out- including the principal amount, the interest rate, the terms of repayment, and the maturity date. Promissory notes typically have a short tenor (maximum tenor of 24 months), a fixed interest rate, and pay interest on a specific schedule.
Some notes are structured with a "put option" for the purchaser of the note. This means that the note holder may "sell" the note back to the issuer at specific dates and under specific terms. The terms and conditions outline the timing of payments and determine when and if you can sell the note.
Promissory notes should be registered with the government in the country in which they are sold and/or with the financial regulators. Registration is important because the process generally involves what is known as "due diligence", meaning that financial professionals, usually including lawyers and accountants, have investigated the notes and companies behind the notes. While due diligence does not guarantee that you will be repaid, it means that you are much more likely to be given accurate information that will help you make an informed decision. If the note is not registered, the investor must do his or her own analysis to assess whether the company can service the debt.
Clients have told me that they like promissory notes for several reasons:
- They are short term in nature
- They offer a fixed rate
- They are predictable and simple to understand- if they invest $10,000 for example, they know that they will get $10,000 back on the maturity date.
The perks of investing in a promissory note include: their simplicity and straightforward nature, the competitive rate of return, potential flexibility to add to the investment or redeem the investment prior to maturity, and its use as an accepted form of collateral.
Conservative investors tend to find promissory notes very attractive, but they are not only suitable investments for the risk averse. If your portfolio has a lot of longer-term instruments such as bonds, a promissory note could be a good addition to your portfolio to handle short-term needs. Talk to your investment advisor today to see if a promissory note is right for your investment needs.
Lisa Minto is the Assistant Vice-President, Personal Financial Planning at Sterling Asset Management. Sterling provides financial advice and instruments in U.S. dollars and other hard currencies to the corporate, individual and institutional investor. Visit our website at www.sterling.com.jm
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