Call and prepayment risk is concerned with the holders having their bonds paid off earlier than the maturity date. This is due to decreasing marker rates, which cause the issuer to call the bonds. It can also occur when the borrowers in a MBS or ABS refinance or pay off their debt earlier than the stated maturity date.

Disadvantages of Investing in Bonds that are Callable or Prepayable

1. It is difficult to develop and forecast the cash flows for the security because of the possible early redemption of the bond.

2. The reinvestment risk is another disadvantage. As rates decrease and bond are called or prepaid, investors will not be able to invest their proceeds at the old rates and will have to use new, lower market rates to put their cash to work.

3. Price compression is the final disadvantage for investors. When rates decline there is a greater chance that the issuer will call the bonds. This compresses or holds the bond at its call price while bonds without this option will continue to increase in market value as rates continue to decrease.

Reinvestment Risk

Related Articles
  1. Investing

    The Risks Of Mortgage-Backed Securities

    Find out how weighted average life guards against prepayment risk.
  2. Investing

    Six Biggest Bond Risks

    Don't assume that you can't lose money in this market - you can. Find out how.
  3. Investing

    When Your Bond Comes Calling

    Callable bonds can leave investors with a pile of cash in a low-interest market. Find out what you can do about it.
  4. Investing

    Key Strategies To Avoid Negative Bond Returns

    It is difficult to make money in bonds in a rising rate environment, but there are ways to avoid losses.
  5. Investing

    Corporate Bond Basics: Learn to Invest

    Understand the basics of corporate bonds to increase your chances of positive returns.
  6. Investing

    Understanding Redemption

    In the investing world, redemption refers to cashing out the value of bonds or mutual funds.
  7. Investing

    Find The Right Bond At The Right Time

    Find out which bonds you should be investing in and when you should be buying them.
Frequently Asked Questions
  1. Where do most fund managers get their market information?

    Many fund managers, whether they manage a mutual fund, trust fund, pension or hedge fund, have access to resources that the ...
  2. What's the difference between short-term investments and marketable securities?

    Understand the difference between short-term investments and marketable equity securities, and learn the importance of short-term ...
  3. Are fringe benefits direct or indirect costs?

    Learn how to allocate costs associated with fringe benefits provided to employees and how to determine when a cost is either ...
  4. How is a bank guarantee different from a traditional loan?

    Read about the differences between a traditional bank loan and a bank guarantee, and why a third party might require a guarantee ...
Trading Center