What Is a Sinker?
- A sinker is a colloquial term for a bond whose payments, coupon and principal, are paid by a sinking fund set up by the issuer.
- Sinkers have an advantage over other periodic-redemption bonds as they allow investors to know precisely when they will get their money back.
- A sinker theoretically has a lower default risk at maturity since the issuer intends to retire a portion of the bond issue early. However, sinker bonds have reinvestment risks similar to those of callable bonds.
Understanding a Sinker
A sinking fund is a means of repaying funds borrowed through a bond issue through periodic payments to a trustee who retires part of the issue by purchasing the bonds in the open market. A sinking fund has regular money deposits—mainly as a way to boost investor confidence in the fund. Putting money into the fund on a regular basis helps the investor have faith that the promised payments will be timely, and that the sinking fund can be utilized to redeem debt securities or preferred stock issues.
A sinker's payment comes from a pool of money that the issuer has set aside to repurchase a portion of the bonds it has issued each year. By repurchasing some bonds before they mature, the company reduces the one-time significant expense of repaying the entire principal of the bond when it reaches its maturity date. Portions of the outstanding bond issue which are paid off are referred to as sunk.
A sinker theoretically has a lower default risk at maturity, since the issuer intends to retire a portion of the bond issue early. However, the sinker bond also has reinvestment risks similar to those of a callable bond. If interest rates decline, the investor could see the bond repurchased by the issuer at either the sinking fund price or the current market price.
There are sinker bonds, and then there are super sinker bonds. Super sinker bonds are generally home financing bonds, where there is a greater risk of bond prepayment. The term also applies to any bond with long-term coupons and short maturity. If a super sinker bond is connecting to a home mortgage, it might be a pre-paid mortgage which allows the mortgage holder to get a long-term yield after a short period. Super sinker bonds attract investors who want a brief maturity but also want longer-term interest rates.
Benefits of a Sinker
Sinker bonds have an advantage over other periodic-redemption bonds. It allows investors to know precisely when they will get their money back. Sinkers set how much premium the investor will get back and when the funds will return. This knowledge lowers the risk that a mortgage-backed bond will be sold or refinanced without your knowledge. Additionally, every payment to the sinking date reduces an investor’s exposure to credit and interest rate risk.