SIE practice questionmediumBonds — Sinking Fund
A sinking fund provision in a bond indenture requires the issuer to:
- AConvert the bonds to equity upon request
- BMaintain a cash reserve equal to the full bond issue at all times
- CRetire a portion of the bond issue periodically before final maturity✓ Correct answer
- DPay bondholders a premium if interest rates decline
Explanation
Why C — Retire a portion of the bond issue periodically before final maturity
A sinking fund requires the issuer to retire (redeem) a portion of the outstanding bonds on a regular schedule before maturity. This reduces default risk for bondholders because the issuer pays down debt over time rather than owing the entire principal at maturity. However, bonds called through the sinking fund expose holders to reinvestment risk.
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