Question

Company X and Company Y are very similar in every dimension. Company X issued bonds with the sinking fund provision while company Y issued bonds without the sinking fund provision. Which company’s bond should offer lower yield?

Answer 1

A firm will benefit from the sinking fund provision which will enable it to buy back the bonds at a price which is less than the market price, the bond can be brought back by the issuer from the secondary market or directly from the issuer.

in this case company X is benefiting from the addition of the sinking fund provision in bonds, so company X has to offer higher yields to attract investors to invest in this bond.

company y has not included the provision for sinking fund, so it can offer lower yields.

the investor buying the bond with the sinking fund provision may not risk the loss of losing its principal, but it may have a risk of losing the interest as the firms has an option to buy back the bonds at a price which is lower than the market price, it can buy back the bonds at a discount. So, here the bond holder now becomes the issuer.