Stock Market

Sinkers

Traditionally, if a bond issue has a "sinking fund" it means that the company periodically sets aside resources to purchase the securities either on the open market or through the exercise of its right to call and retire them prior to maturity. The debt level of the enterprise decreased, increasing the safety of the bonds as a result.

As an investor, you could make a tremendous amount of money if you were lucky enough to receive a call during a period of rising interest rates. As the new, higher rates cause the market value of your bond to fall, you would receive the full par value upon cancellation of your bond and be able to immediately reinvest it at the prevailing higher rates.

The opposite is also true, however. If you were unfortunate enough to receive a call on a bond that was trading at a premium due to a decrease in the general level of interest rates, you would only receive a fraction of the quoted market value of your security. You would then have to reinvest the proceeds at the prevailing lower rates.

The bottom line: sinking funds make a bond issue both more attractive due to the decreased risk of default and less attractive as a result of the call feature that is likely to be embedded in the security. Exercise caution and do your research so you don't encounter any unexpected surprises.

TIP: To paraphrase Will Rogers, "It's not the return on your principal, it's the return of your principal ...." When buying fixed-income securities, don't just look for notes and bonds with the highest yields. If a borrower is willing to pay high interest rates, its credit must not be very good. Junk bonds, for example, are high-yielding bonds from corporations with lousy credit ratings. They may pay a lot of interest but the risk that you will never be paid back part or all of your principal is also very hightoo high to risk. The highest yield, per se, cannot be your objective; it must be the highest yield on the highest quality bonds.