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Finance Glossary

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Sinking Fund

Definition:

A company with bonds outstanding will buy a portion of the bonds each year by making periodic payments to a trustee who then buys a portion of the issue on the open market. Investors prefer sinking funds since they greatly reduce the risk of the issuer's defaulting on repaying the principal at maturity.

Example

Company X has $100 million a year in free cash flow production. It has 10 bonds outstanding, each of which has a $50 million face value. The company takes half of its free cash flow to retire those bonds—or buy them back—thus reducing the leverage and risk to the company's balance sheet.

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