Who is at risk of call risk in a falling interest rate environment?

In a falling interest rate environment, fixed-rate bond investors are particularly at risk of call risk. Call risk refers to the possibility that a bond issuer will redeem (call) a bond before its maturity date, typically because they want to refinance the debt at lower interest rates when market conditions become favorable.

When interest rates decline, issuers of callable bonds, which often include corporate bonds or mortgage-backed securities, are incentivized to call their bonds and reissue new ones at lower rates, thereby saving on interest payments. This process can result in fixed-rate bond investors losing their investment early, forcing them to reinvest the proceeds in a lower interest rate environment where they may not earn as favorable a return as they did with the original bonds.

This risk is unique to fixed-rate bond investors because their returns are based on the fixed coupon payments they receive. Floating-rate bond investors are less affected by falling interest rates as their coupons adjust in response to the current market rates. Thus, they do not face the same reinvestment risks associated with a callable bond being redeemed early. Mortgage lenders are also not directly impacted by call risk in the same manner; they may encounter prepayment risks from borrowers refinancing their loans, but that is distinct from bond call risk. In