Debt Fund – Simplified

Debt Funds are not as innocuous & simple as they sound. The word ‘DEBT’ Means Money Borrowed and Lender get a fixed Interest from it, however, these are still subject to 3 Types of Volatility Parameters/ Risks and investors should not expect a straight-line return from these.

1. Interest Rates Risk.
2. Credit Risk.
3. Liquidity.

Interest Rate:-
A. Bonds Prices tend to move in the opposite direction of Interest rates. Spike in the interest rates means a cut in bond prices.

B. Higher the Duration (Maturity) Period of the Bond, the larger will be the Cut. In general, for every 1% increase or decrease in interest rates, a bond’s price will change approximately 1% in the opposite direction for every year of duration.

CREDIT RISK:-
Credit Risk simply applies to the creditworthiness of the institution whose Bonds/ Security MF has purchased. Higher the credit rating of the issuer of the bond Higher will be the safety. AAA/A1+/AA/A can be considered to be safe, with AAA/A1+ being the safest. Attached is the rating Nomenclature for reference.

Liquidity Risk:-  

Liquidity Means being able to exit the investment when needed. When crisis strikes not having good paper quality can result in a Liquidity crunch. FMP’s are generally locked in for a specific duration and can’t be redeemed.

Yogendra Shah

SNMA Capital Managers.

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