|
Debt Mutual Funds |
|
|
|
|
What is the interest rate risk in debt MFs. Is it anything to worry about? |
|
|
Re: Debt Mutual Funds |
|
|
|
|
Rajiv
|
| 28 August 2008, 11:14:16 |
|
Dear Vikas
Interest rate risk in essence is the risk of loss of principal due to unfavorable movement in the interest rate i.e., an increase in interest rate in the general market.
Let's take an example. You placed a FD 1 lac for 2 years @ 7% last year. Now that the rates have gone up to 10%, your rate is still the same. You would be unhappy and would want to encash your deposit. Assuming that the FD is not prematurely encashable but tradeable in the market, you would get a buyer for less than the face value of 1 lac.
On the contrary if your FD is @ 12% and the current rates are 10% i.e., lower than what you have. You will be happy earning a higher rate and if you sell this deposit in the market. It will sell for more than the face value of 1 lac.
In both the above scenarios the bank is the same and credible, but simply because interest rates have moved up or down, it affect you negatively or positively.
Open-ended fund tend to suffer from interest rate risk for similar reasons. The risk turns favourable in the declining interest rate scenario but unfavourable in a rising interest rate scenario like these days. As a result you could potentially have lower value than amount invested not for any other reason but because interest rates have gone up. Let me also add that this risk is the highest in Gilt Funds followed by long-term debt funds and then short term debt funds. Liquid funds do not carry this risk because of extremely short maturity profile.
FMPs also avoid interest rate risk as they hold the instruments till maturity.
Hope the above answers your query
Happy Investing!!! |
|
|
Re: Debt Mutual Funds |
|
|
|
|
So is it just a question of settling for lesser returns on your mutual fund or even the principal is at risk? |
|
|
Re: Debt Mutual Funds |
|
|
|
|
|
Rajiv
|
| 29 August 2008, 21:48:10 |
|
Dear Vikas
Even the Principal could be at risk. It depends on the maturity profile of your fund (measured by duration) and the extent of rate movement.
Regards
Rajiv |
|
|
|
