Question

Discuss the pros and cons of a sinking fund from the viewpoint of both a firm and its bondholders. Which group do you think would more in favor of such a provision, and why?

Answer 1

Sinking fund is a fund that is kept aside by the corporation to retire the portion of bond issue each year. Sinking fund helps the company in orderly retirement of bond issue.

Pros and cons for a firm

• Pros for a firm is that it sinking fund help in paying off the debt timely and at regular intervals with no payment of interest after retirement of bonds.
• Cons for a firm for the provision of sinking fund is that company might face the liquidity issue for day to day operations as portion of the income goes to sinking fund.

Pros and cons for bond holders

• Pros for bond holder is that bondholders are assured of getting the repayment of the debt amount.
• cons for bondholder is that they won't able to receive interest payment for longer period.

Firms would be more in favour of such provision as they will be able to repay their debt in timely manner with no payment of interest after they retire the bond issues.