Sinkable bond
| Sinkable bond |
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| See also |
Sinkable bond is a bond protected by the sinking fund. That enables a feature of scheduled amortization. Bond is paid not when it matures, but yearly. For example, 10-years sinkable bond will be paid 1/10 each year. Therefore, in the case of sinkable bonds weighted average life of the bond is important (it is shorter than the period until it gets mature).
Uses of the Sinkable bonds
Sinkable bonds may be used to pay off some large investments made e.g. by:
- municipalities or
- local governments.
That can be cheaper for them than taking loan paying interest payments. An issuer of a singable bond is required to buy the predefined amount of the bond at defined points at a sinking price. So if the interest rates fall below the nominal rate of the bond, the sinking fund can allow to repay the amount owed and refinance remaining balance[1]. Retirement of the principal can be through:
- bonds in the open market,
- by the repurchase of the notes or
- a partial call.
The sinking fund
The sinking fund might be either a curse or a blessing to the investor, depending on general bond market conditions during the time when the bonds are sunk. A lot of corporate bonds are both:
- sinkable and
- callable,
which need the calculation of the yield in order to control the lowest yield to the investor. The typical sinking fund will state that the percentage of the total bond issuance or a certain amount can be retired through the issuer at par. Because of some sinkable bonds supply the issuer with the extra option to grow the amount sunk on any given date.
Zero coupon bond
Some kind of debt instruments does not pay coupon interest until the bond is completely repaid. That kind of debt instruments is named zero-coupon bonds. The most famous is one type of zero-coupon bond - United States savings bonds. The United States saving bond is bought together with a discount to its final pay off value. The pay off value is either named:
- the maturity value or
- face amount.
There is a difference between its face amount and its purchase price which express not previously paid, only express the accumulation of interest earned. The United States saving bond share these feature with other zero coupon issues which embrace from the very short-term in the following areas[2]:
- 91day Treasure bills or
- municipal zero coupon debt issues,
- commercial paper emitted through corporations, and
- the very long-term, like 30 year Treasure zeros or
- equally long corporate.
There is a market rate of interest which establishes the discounted price of the debt instrument only when maturity on a zero coupon instrument has no coupon interest paid [3].
Examples of Sinkable bond
- Government bonds: Government bonds are often issued with a sinking fund feature. This allows the issuer to make periodic payments on the bond to reduce the outstanding principal amount. The payments are usually made on a monthly or annual basis and are typically equal to the face value of the bond.
- Corporate bonds: Corporate bonds can also have a sinking fund feature. These bonds are often issued with the intention of paying off the bond over a set period of time. The issuer will make periodic payments to reduce the outstanding principal amount. The payments are usually made on a monthly or annual basis and are usually equal to the face value of the bond.
- Municipal bonds: Municipal bonds are typically issued with a sinking fund feature. These bonds are often issued with the intention of paying off the bond over a set period of time. The issuer will make periodic payments to reduce the outstanding principal amount. The payments are usually made on a monthly or annual basis and are usually equal to the face value of the bond.
Advantages of Sinkable bond
Sinkable bonds offer several advantages. These include:
- Predictable cash flows - By setting up a sinking fund, investors know the exact and timely payments they will receive each year. This provides investors with a steady stream of income and eliminates default risk.
- Lower borrowing costs - Sinkable bonds typically offer lower borrowing costs than other bonds because of the reduced risk associated with them.
- Price stability - As the bond payments are made each year, the overall price of the bond is more stable than other bonds that are not backed by sinking funds.
- Lower risk of default - With the regular payments from the sinking fund, the risk of default is lower than with other bonds.
Limitations of Sinkable bond
- One of the main limitations of sinkable bonds is that the issuer or holder is still exposed to the risk of default. Even though the bond issuer pays out the principal amount in regular installments over the life of the bond, if the issuer defaults, the bond holder could still lose out on some or all of their capital.
- Another limitation is that the interest rate of the bond might be lower than the prevailing market rate. This means that the investor might not be able to get the desired returns on the investment.
- There is also the risk of inflation, which could cause the real value of the bond payments to decline over time.
- Additionally, the investor should take into account the cost of the sinking fund, which could reduce the returns on the bond.
- Lastly, the liquidity of sinkable bonds could be lower than other types of bonds since they cannot be traded in the secondary market.
Sinkable bonds have several additional features that are not present in typical bonds. These features include:
- Callability: Sinkable bonds can be called prior to maturity, allowing the issuer to redeem the bonds from the holders at a predetermined price.
- Conversion: This feature allows investors to convert their bonds into equity shares of the issuer.
- Partially Pre-payable: This feature allows for a portion of the bond to be pre-paid before maturity.
- Interest Rate Caps: This feature allows the issuer to limit the maximum amount of interest that can be paid on the bond.
In summary, Sinkable bonds provide additional features compared to regular bonds, allowing the issuer to have more control over the bond and its repayment schedule. These features can help the issuer to reduce the risk associated with bond issuance and to better manage their liabilities.
Footnotes
References
- Carfi D.,Musolino F., (2012)., Game theory model for European government bonds market stabilization: a saving-State proposal.
- Mecagni M.M., Krijenko J.I.C., Gueye C.A., Weber S., (2014)., Issuing International Sovereign Bonds: Opportunities and Challanges for Sub-Saharan Africa, International Monetary Fund
- Strumeyer G., (2012)., Investing in Fixed Income Securities: Understanding the Bond Market, John Willey and Sons
Author: Mateusz Gołda
