A non-callable bond is a bond that restricts the issuer to recall a bond until it reaches its maturity.
It differs from a callable bond because under the callable right the issuing entity owns the right to repay the bond’s face value as its predetermined value before its maturity date.
A non-callable bond poses an interest rate risk as it mandates the issuer to continue giving the surplus interest rate (the rate at which the bond was issued) under the prevailing rate where the interest is below the surplus interest rate paid by the issuer.
Simply, the non-callable bonds are blocked till its maturity and the issuer is entitled to pay a higher interest rate if the existing interest rate declines.
Such risk possessed by the non-callable bonds make them to be issued at a lower interest rate as compared to callable bonds in order to curb on the interest rate risk.
Many risk-averse investors prefer non-callable bonds since they guarantee fixed-interest payments to stay safe under the volatility of the market.
However, there exists an attribute where the non-callable bond can be diversified into a callable bond after a certain period and such period is termed as a protection period.
What differentiates the non-callable bonds from callable bonds is mentioned below:
Call risk- Non-callable bonds typically benefit the buyers from the interest payments perspective as it instructs the issuer to keep paying interest till the tenure of the bond. The volatility factor lure investors to opt for non-callable bonds.
For example: the initial interest rate at which the bond was issued is 9% and 10 years later the rate surge to 6%. However, investors are in a position to receive 7% interest rates despite the fall in the prevailing market rate until the maturity date.
On the other hand, the callable bond would have given the benefit to the issuer to call back the bond early and re-issue a new bond under the 6% interest rate.
Price & Yield- Callable bonds fall under the risker league than the non-callable bonds and this factor rallies the interest rate of the callable bond to compensate for the higher risk.
However, if the situation makes both the callable and non-callable bonds share the same interest rate, the market price of the callable bond turns lower.
Callable bonds are usually recalled at the call date as specified in the prospectus and the issuer is restricted to call before this period.
Features- Since callable bonds can be redeemed after a particular tenure the issuer pays a premium to the buyer i.e.an extra amount in addition to the face value of the bond. Such feature does not exist under the non-callable bond but it guarantees fixed interest-payments under any circumstances to the investor until the maturity of the bond.
Hence such features typically differentiate the bonds and help the investors to guide in their decision making process.
Higher interest to the investors- As mentioned above, the callable bonds helps the investors to hedge against the decline of the market interest rates and provides a premium to the investors at the time of redemption.Simultaneously this comes at a cost for the investors if the bond is called before they can actually utilise the benefit of the market higher interest rates.
Hence the callable bond offers a higher interest rate and non callable offers lower for the factor of its fixed payment until its maturity.
Before investing it is very important to understand the objective behind an investment as well as equally important to identify your risk bearing capacity.
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