Moreover, a sinking fund bond is de facto a serial bond without the inflexibility inherent with serial bonds which require scheduled payments of principal and interest.
Sinking fund bonds require the issuer to make periodic cash contributions to a sinking fund trustee.
After the initial offering, an increase in interest rates provides the issuer of sinking fund bonds with some favorable options.
Sinking fund bonds give the issuer more flexibility than serial bonds which require scheduled mandatory payments of both principal and interest.
Previous work in this area has analyzed these provisions in terms of interest rate risk,(1) default risk,(2) and the "accumulation game," in which investors increase the value of a sinking fund bond issue by increasing the concentration of its ownership.
Aside from the option to purchase bonds for the purpose of satisfying sinking fund requirements, most sinking fund bond indentures include an American call option which allows the issuer to call part or all of the issue at some schedule of prices.
In 1990, XYZ Corporation issued $100 million of a nine percent ten-year sinking fund bond issue.
Although they based their discussion on sinking-fund debt, we use term bonds instead to simplify the calculations involved, Sinking fund bonds
would produce similar results.
Conventional sinking fund bonds
typically make annual sinking fund payments, which commence after some grace period: |Mathematical Expression Omitted~ during the grace period; |Mathematical Expression Omitted~, a positive constant, on each sinking fund date, with a balloon payment |Mathematical Expression Omitted~ (with S* possibly equal to S) on the maturity date; and |Mathematical Expression Omitted~ for all other dates.