What Are the Sinking Fund Provisions?

Posted in CFA by qmarks on March 20, 2010

Sinking  fund provisions provide for the the repayment of principal through a series of repayments over the life of the issue. For example 20 year issue with a face amount of $300 million may require the issuer retire $20 million of the principal every year beginning the sixth year. This can be accomplished in one of the two ways; Cash or Delivery

Cash payment, issuer may deposit the required cash amount annually with the issue’s trustee who will then retire the applicable proportion of bonds (1/15 in this example) by using a selection method such as a lottery. The bonds selected by the trustee are typically retired at par.

Delivery of securities. the issuer may purchase bonds with a total par value equal to the amount that is to be retired in that year in the market and deliver them to the trustee who will retire them.

If bonds are trading below par value, delivery of bonds purchased in the open market is less expensive alternative. IF the bonds are trading above the par value delivering cash to the trustee to retire the bonds at par is the less expensive way to satisfy the  sinking fund requirement.

Source: CFA Level 1 notes


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