What is Call Risk?

Call risk is a thing that can happen with some bonds. A bond is when a company or the government borrows money from people and pays them back later with extra money called interest.

Some bonds have a special thing called a “call”. This means the company that made the bond can decide to pay back all the money early. They “call” the bond and make people give the bond back to get their money.

Why Companies Call Bonds

Companies like to call bonds when interest rates go down. Interest rates are the extra money companies pay to borrow money. When interest rates are low, companies can borrow money cheaply.

Let’s say a company has bonds that pay high interest. Interest rates go down. Now the company can borrow money at low interest. They use this cheap borrowed money to call the high interest bonds. Then they make new bonds at the low interest rate. This saves them money.

How This Hurts Investors

This is bad for the people who owned the bonds that got called. They were happy getting that high interest. Now they have to find a new place to put their money. But interest rates are low now. They can’t find bonds that pay as much interest as the old bonds did.

Callable Bonds

Not all bonds can be called. Ones that can are called “callable bonds”. The company that makes the bond gets to decide if it can be called or not. They have to say this when they first make the bond. People who buy callable bonds know it might get called.

Why People Still Buy Callable Bonds

Callable bonds usually pay more interest than regular bonds. That high interest is like a reward for the call risk. Some people think the extra interest is worth the chance of the bond getting called.

Also, sometimes a callable bond doesn’t get called. As long as interest rates don’t go too low, the company might not call it. Then the investor gets to keep collecting that high interest.

How to Handle Call Risk

There are some things investors can do to deal with call risk.

Check Interest Rates

Watch what interest rates are doing. If they start going down a lot, callable bonds might get called. Be ready to have your money back and need a new investment.

Build a “Ladder”

Some people build a “bond ladder”. This means buying bonds that mature at different times. For example, buy some bonds that pay back in 1 year, some in 3 years, some in 5 years, etc.

If a bond gets called early, only part of your ladder is affected. You still have other bonds earning interest. And you only have to reinvest some of your money, not all at once.

Consider “Call Protection”

Some callable bonds have special rules called “call protection”. This might mean the bond can’t be called for the first few years. Or it might cost the company extra to call the bond early.

Bonds with call protection are less likely to be called. But they also usually pay less interest. Investors have to decide if they want that extra safety or more interest.