What does Call Risk involve for bondholders?

Call risk specifically pertains to the possibility that a bond issuer will redeem or "call" a bond before its maturity date. This situation typically arises when interest rates decline; issuers may choose to refinance their debt at a lower cost. For bondholders, this poses a risk because they may have to reinvest the returned principal at a lower prevailing interest rate, thus reducing their overall income. The bondholder expected to receive interest payments for a certain duration, and if the bond is called early, they lose out on those future cash flows.

The other choices address different risks associated with bonds but do not accurately reflect the nature of call risk. For instance, selling a bond before maturity pertains to market liquidity but does not capture the involuntary nature of call risk where the issuer actively decides to redeem the bond. Fluctuating interest rates are related to market risk, affecting investment strategies but not directly defining call risk. Unexpected tax liabilities are also a distinct concern unrelated to whether or not a bond is called early. Thus, the choice that defines call risk accurately is the one that highlights the issuer's option to redeem the bond ahead of its scheduled maturity.