Call risk

Call risk is the risk that a bond issuer redeems a callable bond before its scheduled maturity date, cutting off the income stream an investor was expecting and forcing that money to be reinvested, usually at a less attractive rate. Issuers exercise a call option when it benefits them financially, most commonly after interest rates have fallen, since they can then refinance the debt at a lower coupon, similar to a homeowner refinancing a mortgage.

The risk is asymmetric, and it works against the investor. If rates rise after a bond is issued, the issuer has no incentive to call it, since refinancing at a higher rate would cost more, so the investor keeps holding a bond that pays less than the market now offers. If rates fall, the issuer is far more likely to call the bond away right when reinvestment options have gotten worse, leaving the investor to redeploy the proceeds into a market offering lower yields than they had been earning.

Because of call risk, callable bonds typically offer a higher yield than an otherwise comparable noncallable bond, compensating the investor for giving the issuer this option. Bond investors account for this by looking at yield to call in addition to yield to maturity, since the call date, not the final maturity date, may end up being the date that determines the bond's return.