why is a corporate bond not subject to prepayment risk? Is this statement even true?
Generally, it’s true: the corporation cannot (unilaterally) force you to accept an early payoff for your bond. Unless there is a call option or a sinking fund provision, they have no right to pay off the bond early.
thank you for the info.
You’re welcome.
What happens in a sinking fund provision? I am very confused regarding SFP. What is required to be known for the exam as far as SFP is concerned?
In a normal sinking fund, a given percentage of the bond issued must be paid off each year; for example, if a company issues USD10 million par of 10-year bonds, the provision may be that 10% of the issue – USD1 million – must be paid off each year.
If the bonds are trading at premium in the market, then the bonds that are to be retired are chosen at random; if your bond is chosen, you have to sell it back to the company at par. (Technically, the company pays the trustee, and the trustee purchases and retires the bonds, so you’re really selling the bonds to the trustee.) If the bonds are trading at a discount in the market, then the company usually just purchases the bonds at market price and delivers them to the trustee for retirement (and saves a little money in the process).
That’s about it.