Smoking Hot Bonds


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What's going on?

In the latest sign that big corporations are borrowing record sums of cash this year, tobacco giant British American Tobacco (BAT) has raised $17 billion dollars from investors in the second biggest bond offering of the year!

What does this mean?

Selling bonds to investors is a way for companies to raise funds instead of, say, getting money from a bank through a loan. BAT wants to use the money it’s raised from selling bonds to help fund its recently agreed $50 billion purchase of US rival Reynolds American (with Reynolds American on board, BAT will become the world’s largest tobacco company).

Why should I care?

For markets: Companies are on track to raise a record amount via bonds this year.

Interest rates across the world remain near historic lows, and investors are scooping up companies’ bonds in a hunt for returns (corporate bonds pay out a bit more to investors than comparably “safer” ones like government bonds). The extra returns that companies’ bonds offer over government bonds are near their lowest level since before the 2008 financial crisis – suggesting that corporate bonds are unusually popular at the moment and hence people are exploiting almost all the potential extra returns.

The bigger picture: There’s a risk that companies are taking on too much debt.

Companies are taking advantage of this huge demand and are borrowing lots of money by selling bonds to investors. The problem is that this debt will eventually need to be repaid, in most cases with future profits or with more borrowed cash. If the economy takes a turn for the worse, however, companies’ profits would likely take a hit and investors would likely be more wary about lending money – so those original debts could go unpaid. Since companies have borrowed so much recently, the overall risk within the financial system – and to markets – is thus significantly increasing.

Originally posted as part of the Finimize daily email.

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