CDs: sinking fund protection and call protection

[PointBreeze]

I'm putting together a CD ladder at Fidelity, and most of the CDs I'm looking at have attributes that include either SFP (sinking fund protection) or CP (call protection).

Although I have read Fidelity's definitions of these attributes, I'm still not sure what they mean for me as the purchaser. Could someone who knows more than I do explain the ramifications?

Thanks in advance!

 

[njhowie]

I have not ever seen sinking fund when it comes to CDs. There probably isn't, but you just saw the SFP attribute on the line for the CD.

Sinking funds are on bonds, most often municipal bonds. What it means is that there is a schedule of pre-planned redemptions on specific future dates.

Since you are with Fidelity, go to the following link:
https://tinyurl.com/2ah7jnd4

This is the sinking fund schedule for CUSIP 452152BM2, an Illinois State muni. It means on those dates, the indicated amount of bonds will be redeemed. Which bonds get redeemed is by lottery - if yours are redeemed, then you collect your 100 face value on the sinking fund date. So, this becomes important when you are figuring your yield - you need to take into account that it may be redeemed early.

As far as call protection, this means that the issuer has (no CP) or does not have (CD has CP) the ability to redeem the CDs earlier than the maturity date. You will find that CDs with CP will have a lower yield than the equivalent maturity CD without CP. This is because with CP you are guaranteed that the CD will not be called early, and you will collect the stated yield through the maturity date. Without CP, the issuer may redeem your 5 year 4.5% CD after one year if interest rates fall back down. It's not a bad thing that you received 4.5% for only one year, as the one year CD is probably at 4% at the time of purchase. However, then you have reinvestment risk at the end of one year, which you won't have if you took the CD with call protection.

Sinking fund redemption differs from the call in that sinking fund redemptions are mandatory - the schedule and amounts are set at the time the bonds are issued and sold in the primary market. Calls are voluntary - the issuer decides to call if it is advantageous to them financially (i.e. interest rates are lower than the coupon on the CD/bond).

 

[Freedom56]

I'm putting together a CD ladder at Fidelity, and most of the CDs I'm looking at have attributes that include either SFP (sinking fund protection) or CP (call protection).

Although I have read Fidelity's definitions of these attributes, I'm still not sure what they mean for me as the purchaser. Could someone who knows more than I do explain the ramifications?

Thanks in advance!

Most of the corporate notes sold to retail investors directly have sinking fund protection. These notes issued with sinking funds are lower risk since they are backed by the collateral in the fund, and therefore carry lower yields than the institutional bonds from the same issuer. Sinking funds can also be used to finance the redemption of callable bonds.

 

[MercyMe]

I have not ever seen sinking fund when it comes to CDs. There probably isn't, but you just saw the SFP attribute on the line for the CD.

Sinking funds are on bonds, most often municipal bonds. What it means is that there is a schedule of pre-planned redemptions on specific future dates.

Since you are with Fidelity, go to the following link:
https://tinyurl.com/2ah7jnd4

This is the sinking fund schedule for CUSIP 452152BM2, an Illinois State muni. It means on those dates, the indicated amount of bonds will be redeemed. Which bonds get redeemed is by lottery - if yours are redeemed, then you collect your 100 face value on the sinking fund date. So, this becomes important when you are figuring your yield - you need to take into account that it may be redeemed early.

As far as call protection, this means that the issuer has (no CP) or does not have (CD has CP) the ability to redeem the CDs earlier than the maturity date. You will find that CDs with CP will have a lower yield than the equivalent maturity CD without CP. This is because with CP you are guaranteed that the CD will not be called early, and you will collect the stated yield through the maturity date. Without CP, the issuer may redeem your 5 year 4.5% CD after one year if interest rates fall back down. It's not a bad thing that you received 4.5% for only one year, as the one year CD is probably at 4% at the time of purchase. However, then you have reinvestment risk at the end of one year, which you won't have if you took the CD with call protection.

Sinking fund redemption differs from the call in that sinking fund redemptions are mandatory - the schedule and amounts are set at the time the bonds are issued and sold in the primary market. Calls are voluntary - the issuer decides to call if it is advantageous to them financially (i.e. interest rates are lower than the coupon on the CD/bond).

Wow! This is a great reply. Thank you njhowie!