A bondholder will most likely lose if a bond is called because a bond is most likely to be called in a declining interest rate environment. The issuer will likely call the bond and replace it with lower cost (lower coupon debt). The holder faces prepayment and reinvestment risk, because he must reinvest the bond cash flows into lower-yielding current investments.
In bond trading, the call option is bundled with the bond and is not traded separately. The price of a callable bond does not follow the standard inverse relationship. As yields fall, the call option becomes more valuable to the issuer. With a decrease in interest rates, the value of a callable bond can only increase to approximately the call value. Straight bonds will continue to exhibit the inverse relationship between yields and prices as there is no ceiling call price. When yields rise, the value of callable bond may not fall as much as that of a similar straight bond because of the embedded call option feature.
