Investing in debt mutual funds can be a profitable journey, but only if you know the roads and the potholes. Just like a traveller who plans their route before setting off, investors who understand the basics of debt mutual funds are more likely to reach their financial goals.
Debt mutual funds are a type of investment that invests in debt instruments, such as bonds and debentures. These instruments typically offer higher interest rates than savings accounts or fixed deposits, but they also carry some risk. So, before you invest business money in debt funds, you must have a basic understanding of the common terms associated with debt funds.
In this blog post, we will discuss the basics of debt mutual funds and explain some of the most common debt funds jargon investments.
So, let’s dive right in!
Yield:
It refers to the effective returns that debt security will generate for the investors. At the time of the primary issue of debt security at face value, the yield will be equal to the coupon rate—however, the valuation of debt security changes with changes in interest rates. The yield of security is inversely proportional to the price. When the price of the security increases, the yield of such security decreases, as the investors will get the same coupon and redemption value with a higher investment money one would make by buying a bond and holding it for one year.
Credit Ratings:
Before you visit a restaurant in India, don’t you check for its ratings online? You want to ensure that you have a satisfying dining experience. Well, credit ratings work in a similar way, but instead of representing the taste of food, they assess the ability of borrowers in India to repay their debts.
Just like online ratings give you an idea of a restaurant’s quality, credit ratings provide an indication of a borrower’s creditworthiness. These ratings are assigned by independent credit rating agencies in India, such as CRISIL, ICRA, and CARE Ratings. These agencies evaluate the financial health and repayment capabilities of individuals, companies, or financial instruments like bonds. Before investing business money in debt mutual funds, businesses must check for the credit ratings of the underlying securities of a fund.
A high credit rating indicates a lower risk of default for borrowers in India. For example, an AAA or A1+ rating signifies the highest creditworthiness, implying a low likelihood of repayment issues. On the other hand, lower ratings like BB or B imply higher risk, indicating a greater possibility of default.
Coupon:
In debt mutual funds, the term “coupon” refers to the periodic interest payment that investors receive from the underlying debt securities held by the fund. These debt securities can include bonds, debentures, or other fixed-income instruments.
When a company or government issues a bond, it typically promises to pay regular interest payments, known as coupons, to bondholders. The coupon rate is the fixed percentage of the bond’s face value that will be paid as interest over the bond’s term. For example, if a bond has a face value of ₹10,000 and a coupon rate of 5%, the bondholder would receive ₹500 as interest payment annually or in regular intervals until the bond’s maturity.
In a debt mutual fund, the fund manager pools money from multiple investors and invests in a diversified portfolio of debt securities. The interest payments received from these securities, the coupons, are collected by the fund and distributed proportionally to the investors based on the number of units they hold in the fund.
Yield to Maturity:
Yield to maturity is the total rate of return that will have been earned by a bond when it makes all interest payments and repays the original principal. A bond’s YTM is different from its coupon rate, which is the total amount of income it pays for the length of time it’s held. Yield to maturity is also referred to as book yield or redemption yield. It is similar to current yield, which divides annual cash inflows from a bond by the market price of that bond to determine how much
Money Market Securities
Money market securities are short-term debt instruments issued by governments, financial institutions, and corporations. They are characterised by high liquidity and low risk, making them attractive investments for business owners seeking to preserve capital and earn modest returns. These securities have maturities typically ranging from a few days to one year, providing businesses with short-term investment options.
Different Types of Money Market Securities:
- Treasury Bills: Issued by the government, these are short-term debt instruments with maturities of up to one year, providing a low-risk investment option.
- Commercial Paper: Unsecured promissory notes issued by corporations to meet short-term funding needs, offering higher yields than government securities.
- Certificates of Deposit (CDs): Time deposits offered by banks with fixed interest rates and specific maturity dates, providing businesses with a safe and predictable investment option.
- Repurchase Agreements (Repos): Short-term agreements where one party sells securities to another with a commitment to repurchase them at a specified price, offering liquidity and collateralized investments.
- Treasury Bills of Exchange (T-Bills): Short-term debt instruments issued by corporations, providing businesses with an opportunity to invest surplus cash in low-risk instruments.
Investors must note that the Mutual funds that invest in a diversified portfolio of money market securities, provide businesses with convenience, professional management, and a high level of liquidity.
Must Read: Thumb Rules for Business Owners for Investing in Debt Funds.
Expense Ratio:
The expense ratio is an important factor to consider when evaluating debt mutual funds as a potential option to invest business money. It represents the annual expenses incurred by the mutual fund scheme as a percentage of its average net assets. These expenses include management fees, administrative costs, and other operational expenses. A lower expense ratio is generally favourable for investors as it indicates lower costs and can potentially lead to higher returns. It’s essential to compare the expense ratios of different debt mutual funds to select the one that aligns with your investment goals.
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Disclaimer: Mutual funds are subject to market risks, read all scheme-related documents carefully.
The content of this blog is not intended to serve any professional advice or guidance and Shootih takes no responsibility or liability in whatsoever manner for any investment decisions made by the readers of this blog or other blogs. Readers should seek independent professional advice before making any investment decision based on the information provided on this website.
