What it is:
How it works/Example:
When a security is issued, it carries a set term (the time at which the bond may be redeemed for the full value) and coupon rate (the interest rate yield on the bond payable to the bond buyer). Often, bonds are callable, that is, the issuer may decide to retire the bonds earlier than the maturity date. When this happens, the principal and interest are paid up to the date that the bonds are redeemed. However, investors may want to lock in a long term investment at a set rate. To do this, they require that the issuer hold the debt to maturity. These debts are noncallable.
Since noncallable securities typically benefit the buyer, bonds are often issued that carry a mixture of callable and noncallable terms. For example, bonds may be noncallable for a period of time, giving a period of fixed interest payments to the buyer, and then, become callable after that period, to allow the issuer to reset the interest rate on the debt, especially if the market has changed.
Why it matters:
Noncallable bonds take away the issuer's flexibility of retiring debt or even restructuring debt. In exchange for this restriction on the issuer, the debt typically carries a lower interest rate.
Issuers must be careful before structuring non-callable securities since they will be liable for the interest rate for a long time. If the interest rate moves against the issuer during the term of the debt (e.g. the interest rate for comparable maturities may go down), the issuer may be caught paying a higher than market rate for a long time.