Final answer:
A sinking fund is a precautionary financial strategy used by bond issuers to ensure sufficient capital is available by the bond's maturity date for repayment, thereby reducing default risk.
Step-by-step explanation:
A sinking fund is a reserve account in which the issuer of a bond periodically sets aside some part of the bond principal prior to maturity so that enough capital will accumulate by the maturity date to pay off the bond. This financial strategy is commonly used by public companies and municipalities that issue bonds, such as municipal bonds, to ensure they can repay the principal amount to bondholders. A sinking fund reduces the risk that the issuer will default on the bond repayment, and it also can help improve the bond's liquidity, making it more attractive to investors.