Sinking fund provisions, Financial Management

Assignment Help:

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.


Related Discussions:- Sinking fund provisions

Create a data entry and balance sheet, The ledger of AISExperts Inc. showed...

The ledger of AISExperts Inc. showed the following balances after adjustment , but before closing, on December 31, 2012, the end of the current year: Accounts payab

How do we calculate the payback period, How do we calculate the payback per...

How do we calculate the payback period for a proposed capital budgeting project? What are the major criticisms of the payback method? We compute the payback period for a proposed

NPV calc, Capital cost of product a is ? 5 crores and initial capital cost ...

Capital cost of product a is ? 5 crores and initial capital cost of product b is ? 3 crores. Life of product a is 30 years and life of product b is 10 years . The difference in ini

Collection of amounts due - account receivable management, Preferably all c...

Preferably all customers will settle within the agreed terms of trade. If this doesn't happen a company needs to have in place agreed procedures for dealing with overdue accounts.

Theories of the term structure, There are two important term structur...

There are two important term structure theories related to the shapes of the yield curve. First is the Expectations Theory and the second is Market Segmentations

Add or drop analysis, Add or Drop Analysis Lakespring Retirement Village is...

Add or Drop Analysis Lakespring Retirement Village is home to senior citizens who are fairly independent but need assistance with basic health care and occasional meals. Jill Thomp

Estimate sales price of gas, A proposal to extend the ABC Gas Company Ltd's...

A proposal to extend the ABC Gas Company Ltd's gas distribution network to the NOIDA industrial cluster, about 40 km east of Delhi, at distance of about 20 kms from the ABC's exist

Determine the cost, a) Social marketing is the use of normal marketing meth...

a) Social marketing is the use of normal marketing methods to achieve the benefits of social change, such as informing the public about the harm of under-age drinking, rather than

Brainstorming, Brainstor ming An idea production strategy that exc...

Brainstor ming An idea production strategy that exclusively encourages any and all alternatives while withholding any appreciation of those options.

Define the finance function, Q. Define the finance function? Is it a risk-r...

Q. Define the finance function? Is it a risk-return trade off? What is the basic role of a modern financial manager? What is the basic importance of finance function in the mana

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd