Call risk is the degree of probability that the issuer of a security may choose to redeem that security earlier than anticipated. Many types of bonds are structured to allow the issuer to call the bond early, if they feel the move is in their best interests. For investors, this means being aware of the fact that the yield on the investment may not be as high as originally projected.
Many examples of the callable bond allow issuers to redeem the amount invested in the bond at specific points during the life of the security. Often, there is a period of time after the initial purchase during which the bond cannot be called. This helps to reduce some of the call risk involved with the investment, since the bond cannot be redeemed immediately after issue, effectively preventing the investor from earning any significant return.
When looking at any bond issue that could be called before reaching maturity, it is important to read the terms and conditions that apply to the call provision. What is the time frame after purchase that the bond cannot be called? What type of return can be expected if the bond is called immediately after that period? Are their indications that circumstances are likely to develop that would prompt the bond issuer to call the bond early?
Another aspect of call risk is that some bonds are configured to allow the issuer to redeem a current bond, and offer investors the opportunity to reinvest in a new bond issue. With this approach, the investor essentially exchanges one security for another. However, there is some degree of reinvestment risk here, since the rate of return on the new security may or may not be as good as the investor could earn by simply cashing out on the called bond and finding a different investment altogether.
While bonds are considered one of the safest of all investments, it is important to assess the call risk and look beyond the return that can be expected if the bond reaches maturity. By being aware of when the bond can be called, and what the return would be if the bond were called at specific points in the security’s life, it is much easier to decide if the investment is truly in the best interests of the investor. While this process takes a little longer to manage, taking the time to consider the call risk can help an investor sidestep what could be a poor investment choice, and move on to something else that is more likely to generate a higher return.
