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FRM Part I · FRM Exam Part I · Corporate Bonds

A corporate bond has a sinking fund provision requiring the issuer to retire part of the issue each year. From a bondholder's perspective, which is the most accurate assessment of this feature?

A sinking fund lowers credit risk because debt is retired gradually before maturity, but it creates early-redemption risk. Holders whose bonds are chosen may be repaid at par, often when rates have fallen, limiting price appreciation and creating reinvestment risk.

  1. AIt reduces credit risk but exposes holders to the risk that their bonds may be retired early, often at parCorrect
  2. BIt increases credit risk because the issuer's cash is depleted
  3. CIt gives holders the right to sell the bond back to the issuer at any time
  4. DIt converts the bond into equity when the issuer defaults

Explanation

A sinking fund reduces default risk by gradually retiring debt, but bonds selected for retirement are often redeemed at par, which creates reinvestment risk and limits price upside when rates fall. It is not a put or conversion feature.

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