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.(3) This paper studies sinking fund bonds when an issuer has bought some of its own bonds in anticipation of future sinking fund requirements.
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.
While the designation option with respect to prepurchased bonds is included in most sinking fund bond indentures, the designation option with respect to optionally redeemed bonds may or may not be granted.(11) If not, the issuer usually has to apply any optionally redeemed bonds to the most distant, unsatisfied payment dates.
Summary of results: The share of project value accruing to both the pension fund and the sinking fund bonds increases as the degree of financial leverage rises.
Summary of results: The pension fund and the sinking fund bonds both receive a greater share of the value of the project when the pension obligation is larger.
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.
Sinking Fund Bonds. Debentures that require the issuer to establish a (sinking) fund for the orderly retirement of the bonds.
Sinking fund bonds require the issuer to make periodic cash contributions to a sinking fund trustee.
A company that needs to borrow should consider issuing sinking fund bonds. Such bonds permit a company to hedge its borrowing costs when there is a change in interest rates.
After the initial offering, an increase in interest rates provides the issuer of sinking fund bonds with some favorable options.
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.