Define: Call Risk

Call risk refers to the possibility that a bond or other fixed-income security may be called or redeemed by the issuer before its maturity date. This typically occurs when interest rates decline, allowing the issuer to refinance the debt at a lower cost.

When a bond is called, bondholders receive the principal amount of their investment back, but they may miss out on future interest payments. This can be disadvantageous for investors who were relying on the steady income from the bond.

No, issuers typically include call provisions in the bond’s terms and conditions, specifying when and under what circumstances they can call the bond. These provisions are outlined in the bond’s prospectus or offering memorandum.

Issuers may call a bond to take advantage of lower interest rates, to refinance their debt at a lower cost, or to eliminate restrictive covenants associated with the bond. They may also call a bond if they have excess cash and want to reduce their interest expense.

No, bondholders cannot prevent an issuer from exercising its call option. However, they can carefully review the terms of the bond before investing to understand the likelihood of a call and the potential impact on their investment.

Investors can protect themselves from call risk by diversifying their bond portfolio, investing in bonds with longer maturities, or choosing bonds with call protection provisions. These provisions limit the issuer’s ability to call the bond for a certain period of time.

In some cases, an issuer may issue a bond if it is in financial distress. However, this is typically subject to certain conditions and may require the issuer to pay a premium to bondholders.

In general, bondholders do not have legal recourse against an issuer for exercising its call option. As long as the call is done in accordance with the terms and conditions outlined in the bond’s offering documents, the issuer has the right to call the bond.

Investors can stay informed about call risk by regularly reviewing the terms and conditions of their bonds, monitoring interest rate trends, and staying updated on the financial health and actions of the issuer. Consulting with a financial advisor can also provide valuable insights into managing call risk.