What are the possible risks with debt funds?


I am interested in investing in debt funds because the fixed deposits in banks are giving very fewer returns. I would like to know the risk associated with the debt funds and what is the probability of losing the capital also?


There are two major risks when you consider investing in debt funds.

Interest Rate Risk & Credit Risk

Interest rate risk is defined as the risk of change in the value of an asset as a result of volatility in interest rates. It either renders the security in question non-competitive or increases its value. Though the risk is said to arise due to an unexpected move, generally investors are concerned with downside risk. This risk directly affects the fixed-rate security holder. Whenever the interest rate rises, the price of the fixed-income bearing security falls and vice-a-versa.


Credit risk, on the other hand, signifies a bond’s sensitivity to default, or the chance that a portion of the principal and interest will not be paid back to investors. Individual bonds with high credit risk do well as their underlying financial strength improves, but weaken when their finances deteriorate. Entire asset classes can also have high credit risk; these do better when the economy is strengthening and underperform when it slows down.