when would it be beneficial for a debt issuer to add a sinking fund provision to its debt??
Nope - it’s credit enhancement that is supposed to benefit bondholders.
So by adding this provision to their debt…the buyers of the bonds are lowering their credit risk because the issuer is required to retire portions of its debt before maturity rate
What about the prepayment risk… So does it mean that sinking fund provision is good and they are prepared for the reinvestment risk too?
>when would it be beneficial for a debt issuer to add a sinking fund provision to its debt?? It would be beneficial as the issuer if you want the ability to repurchase debt for some reason (e.g. when rates fall). A sinking fund is like diet callable … there are limits to how much you can “call”, but you can still rein in debt when you, as the issuer, choose to do so.
I thought a sinking fund involved a series of mandatory principal reductions, not optional principal reductions. In that way I thought they were not like “diet” calls and would not be sought after by the issuer.
zeroaffinity Wrote: ------------------------------------------------------- > >when would it be beneficial for a debt issuer to > add a sinking fund provision to its debt?? > > It would be beneficial as the issuer if you want > the ability to repurchase debt for some reason > (e.g. when rates fall). A sinking fund is like > diet callable … there are limits to how much you > can “call”, but you can still rein in debt when > you, as the issuer, choose to do so. Nope. A sinking fund is not a call provision except in the sense that it is a mandatory call. An issuer that is not in compliance with the sinking fund provisions is in default. Nobody wants provisions on their bonds that can put them in default. There are not limits to how much you can call and if you want the ability to call only some of the bonds, you just make that part of the indenture (you probably need to have some randomization method so you can’t call specific bonds because you don’t like somebody).
chebychev Wrote: ------------------------------------------------------- > I thought a sinking fund involved a series of > mandatory principal reductions, not optional > principal reductions. In that way I thought they > were not like “diet” calls and would not be sought > after by the issuer. Right.
Thanks. I understood that to be something of value to the issuer instead of the bondholder. It seemed like a type of call or prepayment option since the issuer could retire debt. I guess “could” isn’t as accurate as “forced to”. Sorry if I added to any confusion.
ok, so what about ACCELERATED sinking fund provisions? these favour the issuer… is it because there is an option to pay off more principal (like a call option) ???
Well, an accelerated sinking fund provision gives the issuer options so in that sense it is good for the issuer. But an issuer would much rather just have a call than an accelerated sinking fund because that’s still a sinking fund. An interesting problem might be to look at a bond and decide whether the benefits of the optionality in the accelerated sinking fund outweighed the forced debt retirement cost and liquidity issues. Sounds a little beyond the scope a week before the exam…
Actually the accelerated snking fund would be beneficial because you could call the issue at par rather than at the call price (at least thats what the example in the cfai books imply). So wouldn’t it be of more value than the call option?
sv102307 Wrote: ------------------------------------------------------- > Actually the accelerated snking fund would be > beneficial because you could call the issue at par > rather than at the call price (at least thats what > the example in the cfai books imply). So wouldn’t > it be of more value than the call option? The call price can certainly be par too…