BuyFindarrow_forward

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

Solutions

Chapter
Section
BuyFindarrow_forward

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

A sinking fund can be set up in one of two ways:

  • The corporation makes annual payments to the trustee, who invests the proceeds in securities (frequently government bonds) and uses the accumulated total to retire the bond issue at maturity.
  • The trustee uses the annual payments to retire a portion of the issue each year, calling a given percentage of the issue by a lottery and paying a specified price per bond or buying bonds on the open market, whichever is cheaper.

What are the advantages and disadvantages of each procedure from the viewpoint of the firm and the bondholders?

Summary Introduction

To identify: The advantages and disadvantages of given procedures from the firm’s point of view and the bondholders.

Introduction:

Sinking Fund: Sinking fund refers to the investment made by the issuer of the debt instrument annually, which is used to redeem bonds at maturity.

Answer

First way:

  • Advantages to firm: Investment in government bonds will provide risk free return to the firm.
  • Disadvantages to firm: Investment in government bonds will provide lower return to the firm as compared to market return.
  • Advantages to bondholder: Bondholders will get continuous return from the firm and there is no interest rate risk.
  • Disadvantages to bondholder: Bondholders loose the opportunity to receive the premium on redemption of their bonds.

Second way:

  • Advantages to firm: Retiring of bonds through calling or open market purchase, whichever is low will reduce the cost of the firm for current debt.
  • Disadvantages to firm: It will increase the interest rate which increases the cost of the firm for any additional debts.
  • Advantages to bondholder: Bondholders will get risk free return and their funds will be secured.
  • Disadvantages to bondholder: Bondholders will get lower return if firm uses open market operation.
Explanation
  • From the viewpoint of firm and bondholder both the ways are somewhat advantageous and disadvantageous.
  • First way provide risk free return but lower return than market return to the bondholder.
  • Second way leads to retiring of bonds at par value or market value whichever is less, therefore the return to bondholder is again less but return is assured.
Conclusion

Hence, both the ways have some advantages and disadvantages for firm and bondholders.

The Solution to Your Study Problems

Bartleby provides explanations to thousands of textbook problems written by our experts, many with advanced degrees!

Get Started

Additional Business Solutions

Find more solutions based on key concepts

Show solutions add

Describe the four forms of organizational structure.

Foundations of Business (MindTap Course List)

In what ways is economics a science?

Principles of Economics (MindTap Course List)

NPV A project has annual cash flows of 7,500 for the next 10 years and then 10,000 each year for the following ...

Fundamentals of Financial Management, Concise Edition (with Thomson ONE - Business School Edition, 1 term (6 months) Printed Access Card) (MindTap Course List)

What is the capital consumption allowance?

Economics (MindTap Course List)

Find all the answers to your study problems with bartleby.
Textbook solutions plus Q&A. Get As ASAP arrow_forward