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

Final stage of career, Q. Final stage of career? The final stage in one...

Q. Final stage of career? The final stage in one's career is difficult for everyone but is it hardest for those who have had continued successes in the earlier stages. After se

Budget classification on the basis of flexibility, ON THE BASIS OF FLEXIBIL...

ON THE BASIS OF FLEXIBILITY • Fixed budget: this is designed to stay unchanged irrespective of the volume of output or turnover attained.  The budget remains unchanged over

Multi-period compounding or else future value, Multi-period Compounding or ...

Multi-period Compounding or else Future Value :- If the company determination compounding interest half-yearly (semi-annually) instead of annually then investors will gain as he wi

Capital budgeting model, Develop a scenario for the future growth of the fi...

Develop a scenario for the future growth of the firm e.g. through using a SWOT analysis to identify an appropriate outcome (this will be covered in lectures) • If it is to grow

Put option, Put Option This is a right which is granted in exchange for...

Put Option This is a right which is granted in exchange for an agreed-upon sum to sell property. Options are mostly used frequently in securities transactions it also used stoc

What do you signify by cost of capital, Q. What do you signify by Cost of C...

Q. What do you signify by Cost of Capital? What do you signify by 'Cost of Capital'? What is its meaning and what are the problems in determination of cost of capital? Ans.

Interpretations of profitability ratio''s, Interpretations of Profitability...

Interpretations of Profitability Ratio's - ROA:       ROA or the Return on Assets ratio is the ratio of net profit to total assets and this ratio indicates whether total assets

Determine the calculation of materiality, Determine the calculation of mate...

Determine the calculation of materiality For example: Turnover 1% -1.5% Net assets 1% -2% Net profit 2% -6% Whatever numbers are selected they would be based on r

Explain about money market mutual funds, Q. Explain about Money Market Mutu...

Q. Explain about Money Market Mutual Funds? Money Market Mutual Funds: Money market mutual funds (MMMFs) focus on short-term marketable securities such as TBs, CPs, CDs or call

What are the main criticisms of the payback method, How do we calculate the...

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