Chapter 7 of 12
Debt funds: stability, with risks you should know
8 min read
Debt funds lend money by buying bonds, treasury bills, commercial paper and similar instruments. They tend to be steadier than equity, but they are not risk-free.
How a debt fund earns
Returns come from two places: the interest (called the coupon or accrual) the bonds pay, and the change in the bonds' prices.
Interest-rate risk
Bond prices move opposite to interest rates. When rates rise, existing bonds paying lower rates become less valuable and their prices fall, and the reverse when rates fall. The longer a bond's maturity, the more its price moves. A fund's average maturity or duration tells you how sensitive it is.
Credit risk
Credit risk is the chance that a borrower fails to pay interest or principal. Funds holding only government securities carry very little of it. Funds that reach for higher yields by lending to weaker companies carry more, and the extra yield is the payment for that risk.
Choosing by horizon
- Very short term (days to months): liquid and overnight funds.
- Short term (one to three years): short duration and similar categories.
- Longer term: medium and long duration, gilt funds. These swing more when rates change.
Key takeaways
- Debt funds earn from interest and from bond price changes.
- Rising interest rates push bond prices down; longer duration means a bigger move.
- Higher yield usually means higher credit risk.
This content is for education only and is not investment or tax advice. Mutual fund investments are subject to market risks; read all scheme-related documents carefully.