What type of financial instrument is defined as a legal IOU issued by large, financially sound firms?

The correct choice is a financial instrument known as commercial paper. This instrument is an unsecured, short-term debt obligation, often issued by large corporations, to meet immediate funding needs like inventory purchases or operational expenses.

Commercial paper typically has a maturity ranging from a few days to a maximum of 270 days. Because it is issued by financially stable firms, it often has a low-interest rate compared to other financing options, making it an attractive means for companies to raise funds quickly without the need for collateral.

Understanding the context of other options can clarify how commercial paper stands out. For instance, bonds represent long-term debt instruments that require repayment over an extended period, usually exceeding one year and often secured by assets. Similarly, a commercial note, while another type of short-term debt, generally requires a formal agreement and is often secured, making it distinct from the more flexible commercial paper. Eurodollars, on the other hand, refer specifically to U.S. dollars held in banks outside the United States, and while they can be used in various financial transactions, they do not fit the definition of a direct obligation from a company to pay back borrowed funds.

Thus, commercial paper is specifically designed for short-term needs without the traditional requirements associated with other financial instruments