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What is a sinking fund? How do I tell if one exits? Is it an advantage or disadvantage for me as a retail investor?

A sinking fund is set up by a company to retire, over a period of time, the major part of a preferred share issue or a debt issue prior to maturity. The fund helps pay off the debt issue over the term of the issue and can be compared to principle payments made by a mortgage holder. Even though the debt issue is outstanding to maturity, the small incremental payments made under a sinking fund can make the maturity of a bond issue less onerous on the company. Instead of having to refund the entire issue there may be only a small outstanding balance. A debt issue that carries a sinking fund usually indicates this fact in its title.

A sinking fund is a convenience to the issuer, because some of the issue is paid off earlier than the maturity date so that the amount due on maturity is lower. When the bond matures there is always the risk that the company will have trouble repaying the principle. If the company does not have the funds it may be forced to refinance at higher interest rates. A sinking fund reduces this risk. The sinking fund is not a convenience for the holder, however, since the bonds may be called for sinking fund purposes with no premium given even though the holder may be planning to hold the bonds to maturity. In recent years, companies have chosen to buy bonds on the open market, rather than calling them thus eliminating this disadvantage for the investor. A sinking fund does help to maintain a market for an issue, however, making the bonds more liquid.