when interest rates fall investors only benefit if the bonds are not called as market interest rates go down the bondholders gain by continuing to receive the old interest rate which was higher investors can also sell the bonds to obtain a capital gain however issuers will call their bonds and refinance if interest rates decline substantially eliminating the possibility for bondholders to benefit from rate changes investors in callable bonds lose when interest rates rise but they can t win when rates fall 
as a practical matter corporate bonds often have call provisions while government bonds rarely do that is one reason why investing in government bonds is often a better bet in a falling interest rate environment however corporate bonds still have higher returns in the long run investors should consider prepayment risk as well as default risk before choosing corporate bonds over government bonds requirements for prepayment risknot all bonds have prepayment risk if a bond cannot be called then it does not have prepayment risk a bond is a debt investment in which an entity borrows money from an investor the entity makes regular interest payments to the investor throughout the bond s maturity period at the end of the period it returns the investor s principal bonds can either be callable or noncallable examples of prepayment riskfor a callable bond the higher a bond s interest rate relative to current interest rates the higher the prepayment risk with mortgage backed securities the probability that the underlying mortgages will be refinanced increases as current market interest rates fall further below the old rates for example a homeowner who takes out a mortgage at 7 has a much stronger incentive to refinance after rates drop to 4 or 5 when and if the homeowner refinances those who invested in the original mortgage on the secondary market do not receive the full term of interest payments if they wish to keep investing in the mortgage market they will have to accept lower interest rates or higher default risk investors who purchase a callable bond with a high interest rate take on prepayment risk in addition to being highly correlated with falling interest rates mortgage prepayments are highly correlated with rising home values that s because rising home values provide an incentive for borrowers to trade up their homes or use cash out refinances both of which lead to mortgage prepayments 