How do bond funds work or debt mutual funds work

A debt fund is also a type of mutual fund that generates returns from money received from its investors after investing in various types of government and non-government bonds or deposits. All this basically means that they borrow money and earn interest on the money they lend. This interest that they earn forms the basic basis of the returns they generate for the investors.

 

A bond is like a certificate of deposit money that is issued by the borrower to the lender. Even ordinary individual investors do something similar when they do something as simple as a bank fixed deposit in a bank. When you make a bank fixed deposit with a bank, you fund the bank basically. You can also buy bonds directly, for example, tax-exempt bonds under the Income Tax Act issued by various companies such as REC and Hudco.

 

Exactly what debt funds actually do, except for some differences. First, those who are able to invest in many types of bonds that are not available to the general public. For example, bonds issued by the Government of India. In fact, it is by far the largest borrower in the country. Bonds are also issued by many large and medium-sized businesses in the country. Mutual fund AMCs also invest in them.

 

A very simple way to understand debt funds is to think about them, the kind of interest income they go through, which they get from the bonds they invest. There are also some complications ahead of it. One, unlike fixed deposits that individuals invest in, mutual fund AMCs invest in bonds that are tradable, just as traditionally invested in stocks. Just as there is a stock market where shares are traded, there is also a debt market where different types of bonds are traded. Second, in this debt market, the prices of various bonds can rise or fall, just as they do on the stock markets. If the mutual fund AMC buys a bond and its price rises later, it can earn the additional amount at additional interest. This will give more benefit to investors. Obviously, the fall in price is equally true.

 

Now the point is, why will the prices of bonds rise or fall? There can be many reasons for this. The most important thing is a change in interest rates or any hope of such a change. It assumes that there is a bond that pays interest at the rate of 9 per cent per year. Then, after the revision in the economy, interest rates fall and interest on new bonds starts at 8 per cent. Obviously, the price of old bonds should now be higher than before. After all, investing a given amount in it can earn more money. Its price will now increase already. Mutual fund AMCs that hold it will have their holdings become more valuable and they can earn extra profits by selling this bond. Now it is also true that when interest rates rise, it can reverse again. Despite the expectation of protection, such a situation may actually cause some losses for bond funds.