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

Define the gropus of profit maximisation criterion, Define the gropus of Pr...

Define the gropus of Profit maximisation criterion Profit maximisation criterion has, though, been questioned and criticized on several grounds. Reasons for the opposition in

Net income that the company distributes to shareholders, The dividend is th...

The dividend is the part of the net income that the company distributes to shareholders. As the dividend represents real money, the net income is also real money. Is that true?

Capital budgeting, #how to calculate initial investment cash flows ..

#how to calculate initial investment cash flows ..

Future value, you just started your first job, and you want to buy a house ...

you just started your first job, and you want to buy a house within 3 years. you are currently saving for the down payment. you plan to save $5,000 the first year. You also anticip

How can we measure the present value, How can we measure the Present Value ...

How can we measure the Present Value When we solve for present value, rather than compounding the cash flows to the future, we discount future cash flows to present value to ma

Cost of retained earning, Cost of Retained Earning: - It is on occasion arg...

Cost of Retained Earning: - It is on occasion argued that retained earnings carry no cost since a firm isn't required to pay dividend on retained earnings. Nevertheless this isn't

Interlinkage in the financial markets, Interlinkage in the Financial Market...

Interlinkage in the Financial Markets - Common Features The interlinkage present in the financial markets is essentially due to the fact that all these markets are in the proce

Briefly explain non financial objectives, Briefly Explain Non Financial Obj...

Briefly Explain Non Financial Objectives Monetary statements of any sort are only an expression of organisational activities that can be measured. Lots of the activities of an

Predicting cross-sectional returns, Predicting Cross-Sectional Returns ...

Predicting Cross-Sectional Returns If the market is assumed to be efficient, all securities should lie along the security market line that relates the expected rate of return t

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