I know accelerated sinking funds are bad for the bondholder and good for the issuer because of the reinvestment risk etc… but what about a simple sinking fund, I don’t know if its bad or good for the bondholder because the sinking fund sometimes is used as a way to make sure that the issuer doesn’t default, I would like to know your thoughts on wether the simple sinking fund benefits the issuer or the bondholder. Thank You in advance
At the beginning of time, a sinking fund is good for bond holders because it requires the company to have liquidity and to regularly be paying off their indebtedness in the sinking fund bond. If they don’t comply with the sinking fund provisions, they are in default and you can sue them even if they are paying you all the money that you are due. As such, a sinking fund is credit enhancement. Then time passes and sinking funds become a mixed bag. If you are holding 8% coupon bonds when similar bonds are paying 4%, you like getting 8% coupons and you don’t want your own bonds to be called if the likelihood of payment is high. You still like the credit enhancement. If the bond is trading at 63 and your bond gets called to fulfill the sinking fund and they pay you par, you like that a lot. Issuers like sinking funds when they like calls. If the bond has a sinking fund and a call option, then the sinking fund provisions are always a negative because they require liquidity and redemptions with no optionality. Edit: Even at the beginning of time, a sinking fund still has a problem for the bondholder in that the duration of all the bonds is known but the duration of your particular bond is random and doesn’t depend on interest rates. That makes it tough to hedge.
Thank you Joey, thats a good explanation, but would you say that, taking all this into account, does the sinking fund benefits the bondholder or the issuer?
At the beginning of time an issuer would like to not have a sinking fund more than an investor would like not to have a sinking fund. After that, it depends on interest rates, creditworthiness, and liquidity and can go either way.
Thanks I think I got it