Sinking fund provisions, Financial Management

Sinking fund provisions is a pool of funds set aside to repay the debt. Under this, certain amount of money is kept aside every year form profit. It is then used to retire all the bond issues at the time of maturity or it may be used to pay off only a part of the total issue by the end of the term. The main purpose of the sinking fund provision is to reduce credit risk.

For example, let's say Rachna Trading Company (RTC) sells a bond issue with a Rs.1,000 face value and a 10-year life span. The bonds would pay interest annually. In the bond issue's final year, RTC would need to pay the final round of coupon payments and also repay the entire Rs.1,000 principal amount of each bond outstanding. This could cause a trouble because while it may be effortless for RTC to pay relatively small coupon payments of Rs.50 each year, repaying the Rs.1,000 might cause some cash flow problems, mainly if RTC is in poor financial condition. Nevertheless, the company may be in good shape at present, but it is hard to forecast how much additional cash a company will have in 10 years time.

To decrease its risk of being short on cash 10 years from now, the company may create a sinking fund, which is a pool of money set aside for repurchasing a portion of the outstanding bonds every year. By paying off a portion of its debt each year with the sinking fund, the company will face a much lesser burden at the end of the 10-year period.

Normally, periodic payments for sinking fund requirement are the same for each period. However, some issues may permit changeable periodic payments, where payments change according to certain prescribed conditions set forth in the indenture (bond agreements). Many bond issue agreements contain a condition that grants the issuer the option to retire more than the requirement of sinking fund. This is referred to as an accelerated sinking fund provision.

Posted Date: 9/8/2012 6:30:23 AM | Location : United States

Related Discussions:- Sinking fund provisions, Assignment Help, Ask Question on Sinking fund provisions, Get Answer, Expert's Help, Sinking fund provisions Discussions

Write discussion on Sinking fund provisions
Your posts are moderated
Related Questions
Select a publicly traded company (preferably manufacturing oriented; do not use a financial services company such as a bank or a bank holding company) and obtain a copy of their mo

Sega Inc. expects earnings/dividends to grow at an annual rate of 30 percent for the next 4 years. After that they feel that the market will get saturated and the growth rate will

Expected volatility is a major factor that affects the value of an option. Expected volatility of an option on bond is referred to as 'expected yield volatility'. The

Call-Put Parity P + S = C + E * [1/(1+i)] ^n     where:      P = the market price of the put    S = the market price of the stock    C = the market price of the call

Q. What is Affiliated Company? Affiliated Company - Company or other organization related through common ownership,common control of management or owners or through some other

The management of Nelson plc wish to estimate their firm's equity beta. Nelson has had a stock market quotation for only two months and the financial management feels that it would

I need a report on Accounting or Average Rate of Return. Can you please assist me for Accounting or Average Rate of Return report for about 2500 words?

Discuss the three main trends which have prevailed in international business throughout the last two decades. The 1980s brought a fast integration of financial markets and inter

What are the main flaws of the profit maximisation criterion The main technical flaws of this criterion are i) ambiguity, ii) quality of benefits and iii) timing of be

What are the risks associated with using a large amount of short-term financing for working capital? Using a large amount of short-term financing in general allows funds to be