Question-16: What is the possible risk/disadvantages for an investor in case of bond having “call” provision?

Answer: If you see investor can have, three disadvantages of the call provision and hence faces call risk.

• The cash-flow pattern of a callable bond is not known with certainty.
• Because the issuer can call the bonds when interest rates reduces, and the investor is exposed with reinvestment risk. Because he/she has to reinvest the proceeds received when the bond is called at lower interest rates by borrower.
• Price increase of a bond will be restricted because its a callable bond, it may not rise much above the price at which the issuer can call the bond.

Question-17: Which type of issuer can have callable bonds?

Answer: Usually, Agency, corporate, and municipal bonds can have embedded option like to call, or terminate, the issue before the stated maturity date.

Question-18: How callable bonds are compensated?

Answer: Investor is typically compensated for taking the risk of call by means of a lower price or a higher yield, it is not easy to determine if this compensation is sufficient. And the returns may differ in great amount then non-callable bonds. This also depends on various conditions defined in call provisions and market conditions.

Question-19: Can MBS (Mortgage Backed Security) has the callable options?

Answer: All MBS, which are created based on the real estate mortgage can be called any time. Because the borrower can any time do pre-payment. Hence, all mortgage-backed securities have this option.

Question-20: What do you mean by call risk in case of MBS (mortgage-backed-security)?

Answer: For mortgage-backed securities, the cash-flow depends on prepayments of principal made by the homeowners in the pool of mortgages that is the collateral for the security. And in this case Call risk called prepayment risk.