part of the bond has been repaid back, has been bought back using the sinking fund.
When new bonds are issued,
investment bankers often say that they are floating a new issue.
So it's understandable that a bond retirement program or a bond retirement
fund is actually called a sinking fund, as opposed to floating of new issues.
You're basically retiring bonds, and that's what is called a Sinking Fund.
So the bonds to be retired each year can either be called at a specified price,
or they can even be purchased in the open market at the price that's prevailing.
Occasionally the sinking fund payments are allowed to accumulate, while
earning interest so that the entire issue can eventually be retired at one time.
So if you are an investor, and if you ignore a call feature,
you could be subject to an expensive surprise.
You could be surprised, and that surprise could be pretty expensive for
you in terms of money.
So if the bonds are unexpectedly called,
you as a bond holder might get the principal amount back sooner,
but you may actually lose what may have been an attractive yield.
So, if you recall the example that I discussed earlier, so
a corporation which had issued a bond in 2005, a 20 year bond and the bond had
a fairly high coupon because the interest rates, pre-crisis, were higher then.
And if you are the holder of the bond, you could be enjoying a high interest rate,
a high return, a high coupon on the bond for the next 20 years.
But then if the issuer of the bond decides to call the issue, you may be in for
an expensive surprise in the sense that now if you have to get back the money and
buy a new bond, then that particular bond will typically earn you much less.
The coupon would be much lower than what this bond,
which was issued pre-crisis, in say 2005.
It was 20 year bond, so you could have got a lot of very high interest
payments over a 20 year time period, but because the bond has been
called you may not be enjoying the benefits of the high interest rate.
Now on the other hand, for the corporation, it's a good feature to have
because if a corporation had issued a bond at a fairly high interest rate,
and then interest rates in general came down over a period of time,
then you now have the flexibility to retire the old bond and
basically reissue bonds at a much lower interest rate.
So now if you as a bond holder do not cognize for
this call feature, as I said, you could be in for
an expensive surprise because you may even lose part of your principal.
Now this would occur if a bond had been purchased at a substantial premium,
but it has been called at a price close to par.
So let's say interest rates went down, and you bought the bond at
a fairly high price, because the interest rates are usually lower.
And then you basically now have the principal returned to face value,
because a bond is now called, you could potentially lose money.
So you have to be very careful in terms of the call feature of bonds.
And so, for these reasons, you as a potential board investor,
should carefully examine the call and the sinking fund provision with your broker,
or the bond dealer to better understand the risks that are involved.