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

Net present value of the Lease, how to calculate the net present value when...

how to calculate the net present value when there is company tax rate and rate of return assume that lease is for 2 years payable at the begining of the yr, at the end of two yrs t

What is emerging issues task force, Q. What is Emerging Issues Task Force? ...

Q. What is Emerging Issues Task Force? Emerging Issues Task Force (EITF) - Assists FINANCIAL ACCOUNTING STANDARDS BOARD (FASB) and provides guidance on early identification of

Definition of capital budgeting, Q. Definition of Capital Budgeting? Ca...

Q. Definition of Capital Budgeting? Capital Budgeting is the procedure of making decisions for investment in long-term assets. It is a method of deciding whether or not to inve

Fund managers or the asset management company, Fund Managers or the Asset M...

Fund Managers or the Asset Management Company (amc) The role of fund managers is highly significant in the mutual fund operations. So far, this role is being played by the Mutu

Abnormal earnings valuation model, Abnormal Earnings Valuation Model Ab...

Abnormal Earnings Valuation Model Abnormal Earnings Valuation Model is a method to analyse the value of the firm. The value of the firm can be the sum of three components - the

When underwriting a new security issue for a corporation, What does an inve...

What does an investment banker do when underwriting a new security issue for a corporation?  When underwriting a new security concern an investment banker buys it and then rese

Financial Managemente.., Madhuban group manufactures a product. The followi...

Madhuban group manufactures a product. The following particulars are as follows: 5 Monthly demand 1000 units Cost of placing an order Rs. 100 Annual carrying cost per unit Rs. 15 N

Illustrate the steps of creative accounting, Illustrate the steps of Creati...

Illustrate the steps of Creative accounting Creative accounting include: 1 Timing of transactions. Delaying or hurrying up the despatch of invoices at the yearend to decr

Yield to put, Yield to put is the rate at which the present val...

Yield to put is the rate at which the present value of cash flow to the first put date is equal to the price plus interest rate. It is used for

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