Question

 Q1. A company generally has two ways to handle its sinking fund: It can either call its bond or purchase its bonds on the open market. If you are the financial manager of the company, how should you do?

Q6: Compare the interest rate risk and reinvestment rate risk between a 10-year bond and a 1-year bond. We assume the two bonds have the same coupon rate at 10%.

Answer 1

Q 1 . A company has certain expense, which it has to incur from time to time eg, repayment of a long-term debt, replacement of depreciated assets etc. A sinking fund is a type of fund which asides money for a particular purpose like timely repayment of the debt, purchase of fixed asset etc.

Company can take decision to all call its bond or purchase its bonds on the open market. One of the ways it can decide the same is by the prevailing interest rates.

In case the interest rates decrease, the bond prices issued by the company increases, thus the company can call the bonds at the face value, which is lower than the current market price of the bonds.