Sinking fund is a tool or a mean of reimbursing those funds that were borrowed from another party by issuing bonds, preferred stocks or debentures. The issuer of the bond pays payments in the form of chunks to the trustee who purchases the bonds of the issuer in the open financial market. In other words sinking fund may be defined as the stipulation in some of the bond agreements where the bond issuer puts aside some money to pay the bondholders at maturity of the bonds. A separate account is maintained by the issuer in such condition in which the issuer accumulates funds or money to repay the bond at the time of maturity.
The sinking fund helps issuer in the way that the entire principle amount is not to be paid by the bond issuer at the time of the maturity of the bonds as one or another part backs up the issuer by buying the portion of issue on annual bases. This portion is bought at the rate of fixed market value of the bond or the current par value of the bond depending whichever of the both is less. With the help of sinking fund provision the interest rate risk associated with the bond issue is also declines as the existing accumulated debt is replaced with the low price or low market value yielding bonds.
Sinking Fund appends a kind of security or safety to the bond issues as with the help of this approach the issuing company can avoid default that may occur during the repayment of the bonds. The safety associated with sinking fund also adds in the interest value of the bonds offered by the company in open market place.
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