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Interest Rates and Bond Fund

What is interest rate risk in a bond fund and how to manage it?

by Holistic Leave a Comment | Filed Under: Mutual Funds

Bond fund and interest rate risk

It is general perception that the equity market is more volatile than the bond market. However, it is a misnomer to believe that bonds are perennially safe. The greatest risk associated with the bond market is the interest rate risk.

What is interest rate risk?

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A simple example will highlight how the bond market operates and the way interest rates make an impact on its intrinsic value.

Supposing a bond with duration of 5 years with a face value of Rs.1000/- and a coupon rate of 6% is available in the market. Now a new bond with the same periodicity and face value arrives in the market with a coupon rate of 7%, immediately the demand for the first bond goes down as investors can now earn a higher interest by purchasing the later type of bond.

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As the demand for a bond with lower interest rate goes down after the interest rate hike, the price of the bond will go down and may be quoted in the market at a discounted price. This leads to a loss in the form of capital erosion for the investors.

How duration amplifies the interest rate risk?

Any comparison between bonds with different coupon rates is incomplete if the duration to maturity is not taken into account. In order that proper comparison be carried out for the evaluation of bonds, it is necessary that a uniform measurement procedure is adopted. Such a measurement will help to gauge the sensitivity of the bonds during different situations by taking a combined view of the coupon rates and the flow of cash for a given duration.

If duration is considered to be the key to comparison then an index of 4 would mean that bond prices would go up by 4% if there is a change of 1% in interest rates and vice versa.

interest rate

The investor will find the comparison useful when it is precise and can accurately predict the future of the bond. In this context the concept of effective duration is an effective measure. The ratio of percentage change in bond price vis-à-vis the change in returns or yields provides investors a clear picture about the future of the bonds.

Capital gain or capital erosion in a bond because of interest rate movement, will be amplified by the duration of the fund. If the duration of the bond fund is longer the gain or loss because of interest rate movement will be higher.

How to manage interest rate risk?

When you are planning to invest in a fund…

  • Choose a bond fund which will not frequently change the duration of the fund and
  • Choose a bond fund which has the duration closer to your time horizon of the investment.

As a first step list down the funds which will not change the duration of the funds. Then in the second step match your period of investment with the duration of the funds. i.e. If you are investing for 2 years, select a fund which has the duration closer to 2 years.

The secret behind the above strategy

The interest rate risk and the resultant capital loss will become a temporary phenomenon and the loss will be notional and not actual, if the bonds are held till maturity.

i.e. On maturity of the bond, the bond issuer will return the principal amount to the bond holder. So the price fluctuation because of interest rate movement will not have any effect on maturity.

The accrual based debt funds generally buy securities and hold it till maturity. This brings a lot of predictability on the returns and assures better safety for investors . To make all the successful investment principles and techniques work in your favour, you may test-drive our services by opting for

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Jey S
24. September, 2021.
I have been using Holistic Investment Planners for the last three years. Mr. Srinivasavaradhan answered all my questions and doubts very patiently during the first free consultation. I was able to clearly define my short-, medium- and long-term goals once I signed up for the comprehensive plan and got their investment plan suggestion to achieve my goals. They are very polite and highly professional whenever I contact them for any queries or make investments. They never pressurize you to invest on their recommended financial products. I would have been lost money by investing directly without their help since I do not have time and knowledge about different financial products. Risk planning is also done as part of financial planning. Truly, they are holistic planners when it comes to your financial planning. They help you to define your life goals, understand your financial resources and establish a plan to invest towards reaching those goals. They do review your plan as you progress to make sure that you are on correct path to achieve those goals. Kudos to the team and keep up the good work!!! I am happy that I found holistic investment planners for my financial planning and management.
aksaswadkar
aksaswadkar
24. September, 2021.
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Lionel Faber
16. September, 2021.
I've been availing their services for the past year. They are highly knowledgeable in the field and are very patient with all doubts and queries. Personalized financial planning is provided keeping your short term, medium term and long term goals in mind. They do not pressurize you to purchase schemes of their choice. They provide their input and suggestions and leave the decision up to you which shows their honesty and high principle.
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Nitesh Agrawal
Nitesh Agrawal
6. September, 2021.
I have been using Holistic Investment Planners from last one year. The journey has been fantastic. Being a finance person myself I always thought we can look after and plan own finances also. However, due to lack of time and deciplain the things are not always as desired. After joining with Holistic Investment for the first time Icame to know the Financial goals and quantified them. Some dreams were unrealistic based on the earnings and savings so had a reality check. Also got the information and deciplain of investing on regular and more rewarding securities. I definetly suggest to use Holistic Investment Planners. They are professionals, available and hear youor full story before presenting plans. They are flexile in the sense if there are some urgent deviations required, they help to plan the same. For all professionals/individuals I would suggest using professional help of Holistic Investment Planners for best results in long term investment and financial goals achivements. Last advise will be to start early in your life. It really pays well to start in the beginning itself else the dreams needs to adjust :)
Swetha Vasanth
Swetha Vasanth
6. September, 2021.
This is my first year service with the Holistic Team and I would say that they are very much helpful in creating a financial plan and follow ups during the year. I would definitely suggest them if anyone who is willing to proceed with their savings professionally.
Joseph Mathias
Joseph Mathias
6. September, 2021.
I came to know about Holistic Investment Planners online while searching for different investment ideas. Once I contacted them the journey was very smooth. Mr. Ramalingam explained all the aspects of Financial planning in detail and it opened my mind. I realized how important it is to have a Financial planning. Mr. Rajan suggested all the requirements as per my goals and made a Investment plan keeping in mind of my goals. I started my Investment journey with them. I wish I had done it some years back then it would have been in a different level. Review meetings were held every six month to check the implementation of the plan and check the results as per the requirements and to check if any changes required. Overall it was a good experience with Holistic Investment team and would like to continue in the years to come.
Srinvas Kannan
Srinvas Kannan
30. July, 2021.
I came across Holistic investment planners almost 5-6 years back, but I did not have the trust since I had met a few of them who did not sound promising. Then I started investing through a financial advisor of my friend. After 4 years of investing the returns were very low. I was disappointed and started looking for financial advisors when I came across Holistic investment. I had a detailed discussion about my goals and the way they would approach achieving my goal before deciding to switch my investments to them. After a thorough analysis of my then existing portfolios, they suggested new ones and we zeroed-in on 6 schemes/funds where our investment would be split. I am glad I made the decision of switching over and taking Holistic planner's advise, my returns are handsome and I only wish I could have taken their help/advise 5 years back itself. Neverthless, I would like to recommend their services for investment and financial advise if someone is serious about their investments.
Shivaram Andiappan Selvaraj
Shivaram Andiappan Selvaraj
3. July, 2021.
I got a free first time consultation. I got my doubts resolved. They also gave additional advises for investment planning which was also useful.
Nellai B
Nellai B
26. June, 2021.
I have been associated with them for the past three years. They are very professional and polite in answering all our questions. I have complete trust in their suggestions. I strongly recommend for anyone. I am looking forward to have strong and successful association with them.
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