Sinking Fund Provision

A sinking fund is a mandatory redemption schedule: the issuer must retire a percentage of the bond issue each year (e.g., 5% annually starting in year 10). Bonds to be redeemed are selected by lottery at par. For bondholders, sinking funds reduce credit risk (less debt outstanding = lower default probability) but create reinvestment risk (your bond might get called early at par, forcing you to reinvest at lower yields). Think of it as forced early retirement for bonds: instead of one big maturity, the issue shrinks over time. Sinking funds were common in the 1970s-80s but are rarer today. If your bond is called via sinking fund and you bought it at 105, you lose 5 points. Conversely, if you bought at 95, you gain 5 points.