Why sinking fund requirement

Sample 1. Sample 2. Sample 3. Sinking Fund Requirement means, with respect to the Term Bonds , if any, for any Bond Year , the principal amount fixed or computed as provided in the Series Certificate for the retirement of the Term Bonds by purchase or redemption on July 1 of the following Bond Year.

Sinking Fund Requirement means, with respect to the Term Bonds and for any Bond Year , the principal amount fixed or computed for retirement by purchase or redemption on or prior to January 1 of the following Bond Year. Examples of Sinking Fund Requirement in a sentence For purposes of this definition, the principal and interest portions of the Accreted Value of Capital Appreciation Bonds becoming due at maturity or by virtue of a Sinking Fund Requirement shall be included in the calculations of accrued and unpaid and accruing interest or principal in such manner and during such period of time as is specified in the Parity Bond Documents applicable to such Capital Appreciation Bonds.

Measure content performance. Develop and improve products. List of Partners vendors. A sinking fund is a means of repaying funds borrowed through a bond issue through periodic payments to a trustee who retires part of the issue by purchasing the bonds in the open market.

The sinking fund provision is really just a pool of money set aside by a corporation to help repay previous issues and keep it more financially stable as it sells bonds to investors. Typically, corporate bond agreements also called indentures require a company to make periodic interest payments to bondholders throughout the life of the bond, and then repay the principal amount of the bond at the end of the bond's lifespan.

The bonds would likely pay interest payments called coupon payments to their owners each year. After all, the company may be in good shape today, but it is difficult to predict how much spare cash a company will have in ten years' time.

To lessen its risk of being short on cash ten years from now, the company may create a sinking fund, which is a pool of money set aside for repurchasing a portion of the existing bonds every year. By paying off a portion of its debt each year with the sinking fund, the company will face a much smaller final bill at the end of the year period. As an investor, you need to understand the implications a sinking fund can have on your bond returns.

Sinking fund provisions usually allow the company to repurchase its bonds periodically and at a specified sinking fund price usually the bonds' par value or the prevailing current market price. Because of this, companies generally spend the dollars in their sinking funds to repurchase bonds when interest rates have fallen which means the market price of their existing bonds have risen , as they can repurchase the bonds at the specified sinking fund price, which is lower than the market price.

This mechanism may sound very similar to a callable bond , but there are a few important differences investors should be aware of. First, there is a limit to how much of the bond issue the company may repurchase at the sinking fund price whereas call provisions generally allow the company to repurchase the entire issue at its discretion. However, sinking fund prices established in bond indentures are usually lower than call prices , so even though an investor's bond may be less likely to be repurchased through a sinking fund provision than a call provision , the holder of the bond with the sinking fund stands to lose more money should the sinking fund repurchase actually occur.

As you can see, a sinking fund provision makes a bond issue simultaneously more attractive to an investor through the decreased risk of default at maturity and less attractive through the repurchase risk associated with the sinking fund price. Investors should review the details of a sinking fund provision in a bond's indenture and determine their own preferences before investing their money into any corporate bond.

Corporate Bonds. Fixed Income Essentials. As a result, the company has refinanced its debt by paying off the higher-yielding callable bonds with the newly-issued debt at a lower interest rate.

Also, if interest rates decrease, which would result in higher bond prices, the face value of the bonds would be lower than current market prices. In this case, the bonds could be called by the company who redeems the bonds from investors at face value.

The investors would lose some of their interest payments, resulting in less long-term income. Sinking funds may be used to buy back preferred stock. Preferred stock usually pays a more attractive dividend than common equity shares. A company could set aside cash deposits to be used as a sinking fund to retire preferred stock. In some cases, the stock can have a call option attached to it, meaning the company has the right to repurchase the stock at a predetermined price.

A sinking fund is typically listed as a noncurrent asset —or long-term asset—on a company's balance sheet and is often included in the listing for long-term investments or other investments. Companies that are capital intensive usually issue long-term bonds to fund purchases of new plant and equipment. Oil and gas companies are capital intensive because they require a significant amount of capital or money to fund long-term operations such as oil rigs and drilling equipment. Let's say for example that ExxonMobil Corp.

Interest payments were to be paid semiannually to bondholders. The company would have also had to pay five years of interest payments on all of the debt. If economic conditions had deteriorated or the price of oil collapsed, Exxon might have had a cash shortfall due to lower revenues and not been able to meet its debt payment. Paying the debt early via a sinking fund saves a company interest expense and prevents the company from being put in financial difficulties in the long-term if economic or financial conditions worsen.

Also, the sinking fund allows ExxonMobil the option to borrow more money if needed. In our example above, let's say by year three, the company needed to issue another bond for additional capital. Corporate Bonds. Fixed Income Essentials. Your Privacy Rights. To change or withdraw your consent choices for Investopedia.

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