Sinking Fund
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A sinking fund can be set up in one of two ways
a. The corporation makes annual payments to the trustee, who invests the proceeds in securities (frequently government bonds) and uses the accumulated total to retire the bond issue at maturity.
b. The trustee uses the annual payments to retrieve a portion of the issue each year, either calling a given percentage of the issue by a latterly and paying a specified price per bond or buying bonds on the open market, whichever is cheaper.
What are the advantages and disadvantages of each procedure from the viewpoint of (a) the firm and (b) the bondholders?
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Solution Summary
The solution explains the advantages and disadvantages of setting up a sinking fund
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(a) The firm
From the firm perspective, option (a) is not advantegous as it has to invest money in low yielding government securities. The bonds of the firm would have a yield higher than that offered by government securities. Thus for the firm, option b is better as it is able to ...
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