What is a Sinker
A sinker is a bond with payments provided by the issuer's sinking fund. A sinker bond has interest and principal payments stemming from the proceeds of a sinking fund. 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. Sinking 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.
BREAKING DOWN Sinker
The sinking bond payment is 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 avoids the significant expense of repaying the entire principal of the bond at one time, when it reaches its maturity date.
The bond issuer creates a dedicated fund which has set sums paid off over time. 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.
The Advantage of Sinker Bonds
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.