Amortization means the reduction of debt. A corporation issuing bonds may prefer to provide for their payment at maturity through a sinking fund, for the account of which a stated sum is set aside each year, rather than to rely on other means to discharge the debt when it falls due.

This policy has many advantages. It makes it muck easier to discharge the debt, as the payments made when spread over a period of years are less burdensome than when provided in a lump sum. Then, also, contributions to a sinking fund to amortize gradually a bonded obligation, can be made to earn interest, which interest, compounding itself, also accumulates money towards the payment of the debt. Thus money is made to earn money.

It is frequently provided, in the interest of a sinking fund, that bonds, for the retirement of which the sinking fund has been created, can be repurchased at a stated price, either by call upon the holders of the bonds or in the open market. A corporation then either cancels the bonds and reduces its fixed charges, or pays into the sinking fund the coupons of the bonds which have been purchased for its account.

There are various ways by which a sinking fund operates. They cannot all be mentioned here. But a bond that has set aside for its retirement a sinking fund, or for which arrangements have been made to amortize by gradual payments, is considerably strengthened as an investment where the operations of a corporation are profitable.

The fact that a sinking fund has been created for the retirement of certain bonds is not in itself a proof of strength. If a corporation is making no profit, it cannot lay aside money for its sinking fund. Certainly it cannot take the necessary money out of its capital, as that only weakens the corporation in one direction, without strengthening it in another.

The advantage of amortization is in connection with bonds issued by producing mine companies, and cor-porations operating in perishable assets. By setting aside a part of the proceeds from the sale of their products, they are more certain to retire the bonds when they mature. Without a sinking fund, such corporations face the danger of not having the money on hand to pay off the bonds should their properties exhaust themselves.

This matter is likewise of some importance in connection with non-productive enterprises such as sewers, streets, parks, etc., of municipalities. The bonds of a city which provides an adequate sinking fund for their redemption are more certain of being paid at maturity than others for which no such provisions have-been made.

Amortization And Sinking Funds. Test Questions

1. What is the meaning of amortization?

2. What are the arguments in favor of providing a sinking fund?

3. In what way does an amortization plan strengthen a bond?

4. Why is a sinking fund of special importance in connection with concerns whose assets are subject to exhaustion or to depreciation in value?