Call risk

Definition

Call risk is the risk that a bond may be redeemed by the issuer before its maturity date, typically when interest rates fall. This results in the bondholder receiving their principal back earlier than expected and potentially reinvesting at lower interest rates.

5 Must Know Facts For Your Next Test

1. Call risk is more prevalent in callable bonds, which give issuers the right to redeem before maturity.
2. Bonds are usually called when interest rates decline, allowing issuers to refinance at lower costs.
3. Investors face reinvestment risk with call risk, where they might have to invest at lower yields following a call.
4. Callable bonds often offer higher yields than non-callable bonds to compensate for call risk.
5. Call protection period is a timeframe during which the bond cannot be called by the issuer.

Review Questions

• What triggers an issuer to exercise their option to call a bond?
• Why do callable bonds typically offer higher yields compared to non-callable bonds?
• How does call risk relate to reinvestment risk?

Related terms

Callable Bond: A bond that can be redeemed by the issuer before its maturity date.

Reinvestment Risk: The danger that proceeds from an investment will earn less when re-invested.

Yield Spread: The difference in yields between different types of bonds, often reflecting differing risks.