LeoGlossary: Sinking Fund

In the case of term bonds, interest is paid each year, but the entire amount of principal matures at once at the end of the term. A sinking fund may be used to “save up” in advance for the one large principal payment when the bonds mature, or it may be subject to so-called mandatory redemption requirements. Under these requirements, the term bond is subject to redemption in part by lot on payment dates, usually beginning a few years prior to the maturity date. By reducing the amount of bonds held by bondholders, the issuer pays less in debt service each year; thus, in some respect, a sinking fund arrangement is functionally similar to later maturing serial bonds. For example a term bond issued in 2019 maturing in 2040 may have redemption dates beginning in 2036.

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