All of us evaluate fund attributes and portfolio construct while investing in equity mutual funds. But the same approach is not followed when it comes to debt funds as we are not well versed with various aspects of debt funds. So let’s understand them before investing in debt funds.
Risk Element- Debt mutual fund inherit a few risks
Credit risk- This is the risk of loss of principle or any other cash flow as the borrower is unable to meet his financial obligations.
Interest rate risk- Fluctuations in interest rates affect the prices of bonds. As the interest rate fall bond prices rise and vice versa.
Re-investment risk- When the bond was initially purchased, the future coupon may not be re-invested at prevailing interest rates.
The fund’s investment objective and the fund managers view on interest rate movements; the schemes asset allocation is decided. To combat interest rate risk the fund manager may tactically alter the asset allocation.
The credit risk of a scheme can be reduced by credit rating of instruments.
It refers to the maturity of all holdings of fund’s portfolio.
The modified duration measures the price sensitivity to the changes in rates i.e. when interest rate falls. Bond prices increase and vice versa. Therefore bond prices are inversely related to interest rates.
The total return anticipated on a bond when the bond is held till maturity.
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