What is inconceivable?
A non-redeemable security is a financial security which can only be redeemed early by the issuer with the payment of a penalty. The issuer of a non-redeemable bond is exposed to interest rate risk because, when issued, it blocks the interest rate that it will pay until the maturity of the security. If interest rates fall, the issuer must continue to pay the higher rate until the security matures.
Most treasury securities and municipal bonds are non-refundable.
Understand not callable
Preferred shares and corporate bonds have provisions for calls that are set out in the prospectus or trust indenture when the securities are issued. An appeal clause may indicate that an obligation is callable or non-callable. The redeemable security can be redeemed early and pays a premium to compensate the investor for the risk that he will not earn any additional interest if the security is redeemed before its maturity date. Bonds are often “called” when interest rates fall, because lower interest rates allow the company to refinance its debt at a lower cost. For example, if prevailing interest rates in the economy decrease to 3%, an existing bond that pays a 4% coupon will represent a higher cost of borrowing for the issuing company. To reduce costs, the issuing company may decide to repay existing bonds and reissue them at a lower interest rate. Although this decision is advantageous for issuers, bond investors are disadvantaged because they are exposed to the risk of reinvestment – risk of reinvesting the product at a lower interest rate.
A bond may also be non-redeemable during the life of the bond or until a predetermined period has passed after its initial issue. A fully non-redeemable bond cannot be redeemed early by the issuer regardless of the level of market interest rates. Non-redeemable bondholders are protected from loss of income caused by early redemption. They receive regular interest or coupon payments until the bond matures, which ensures the predictability of their interest income and their rate of return. Bond issuers are at a disadvantage, however, because they may be forced to pay higher interest on a bond and, therefore, a higher cost of debt, when interest rates have fallen. As a result, non-redeemable bonds tend to pay investors a lower interest rate than prepayable bonds. However, the risk is lower for the investor, who is guaranteed to receive the interest rate indicated for the duration of the security.
Certain redeemable bonds are not redeemable for a specified period after their first issue. This period is called the call protection period. For example, a trust indenture may stipulate that a 20-year bond can only be called eight years after its date of issue. The call protection period ensures that bondholders continue to receive interest payments for at least eight years, during which time the bonds remain non-refundable. Once the call protection has ended, the non-redeemable security becomes callable and the date on which an issuer can redeem its bonds is called the first redemption date. If the issuer purchases its bonds before maturity due to more attractive refinancing rates, interest payments will cease to be paid to bondholders.
A non-redeemable bond or preferred stock that is redeemed before the maturity date or during the call protection period will result in the payment of a stiff penalty.