Debt Securities are subject to the risk of an issuer’s inability to meet principal and interest payments
on the obligation (Credit Risk) on the due date(s) and may also be subject to price volatility due to
such factors as interest rate sensitivity, market perception of the creditworthiness of the issuer and
general market liquidity (Market Risk).
The timing of transactions in debt obligations, which will often depend on the timing of the Purchases and
Redemptions in the Scheme, may result in capital appreciation or depreciation because the value of debt
obligations generally varies inversely with the prevailing interest rates.
Interest Rate Risk
Market value of fixed income securities is generally inversely related to
interest rate movement. Generally, when interest rates rise, prices of existing fixed income securities
fall and when interest rates drop, such prices increase. Accordingly, value of a scheme portfolio may
fall if the market interest rate rise and may appreciate when the market interest rate comes down. The
extent of fall or rise in the prices depends upon the coupon and maturity of the security. It also
depends upon the yield level at which the security is being traded.
Credit Risk
This is risk associated with default on interest and /or principal amounts by issuers
of fixed income securities. In case of a default, scheme may not fully receive the due amounts and NAV
of the scheme may fall to the extent of default. Even when there is no default, the price of a security
may change with expected changes in the credit rating of the issuer. It may be mentioned here that a
government security is a sovereign security and is safer. Corporate bonds carry a higher amount of
credit risk than government securities. Within corporate bonds also there are different levels of safety
and a bond rated higher by a rating agency is safer than a bond rated lower by the same rating agency.
Spread Risk
Credit spreads on corporate bonds may change with varying market conditions. Market
value of debt securities in portfolio may depreciate if the credit spreads widen and vice versa. Similarly,
in case of floating rate securities, if the spreads over the benchmark security / index widen, then the
value of such securities may depreciate.
Liquidity Risk
Liquidity risk refers to the ease with which securities can be sold at or near its valuation
yield-to-maturity (YTM) or true value. Liquidity condition in market varies from time to time.
The liquidity of a bond may change, depending on market conditions leading to changes in the liquidity
premium attached to the price of the bond. In an environment of tight liquidity, necessity to sell
securities may have higher than usual impact cost. Further, liquidity of any particular security in
portfolio may lessen depending on market condition, requiring higher discount at the time of selling.
The primary measure of liquidity risk is the spread between the bid price and the offer price quoted
by a dealer. Trading volumes, settlement periods and transfer procedures may restrict the liquidity of
some of these investments. Different segments of the Indian financial markets have different settlement
periods, and such periods may be extended significantly by unforeseen circumstances. Further, delays in
settlement could result in temporary periods when a portion of the assets of the Scheme are not invested
and no return is earned thereon or the Scheme may miss attractive investment opportunities.
At the time of selling the security, the security may become illiquid, leading to loss in value of the
portfolio. The purchase price and subsequent valuation of restricted and illiquid securities may reflect
a discount, which may be significant, from the market price of comparable securities for which a liquid
market exists.
Counterparty Risk
This is the risk of failure of the counterparty to a transaction to deliver securities against consideration
received or to pay consideration against securities delivered, in full or in part or as per the agreed
specification. There could be losses to the fund in case of a counterparty default.
Prepayment Risk
This arises when the borrower pays off the loan sooner than the due date. This may result in a change in
the yield and tenor for the mutual fund scheme. When interest rates decline, borrowers tend to pay off high
interest loans with money borrowed at a lower interest rate, which shortens the average maturity of Asset-backed
securities (ABS). However, there is some prepayment risk even if interest rates rise, such as when an owner
pays off a mortgage when the house is sold or an auto loan is paid off when the car is sold. Since prepayment
risk increases when interest rates decline, this also introduces reinvestment risk, which is the risk that
the principal may only be reinvested at a lower rate.
Re-investment Risk
Investments in fixed income securities carry re-investment risk as the interest rates prevailing on the
coupon payment or maturity dates may differ from the original coupon of the bond (the purchase yield of
the security). This may result in final realized yield to be lower than that expected at the time
The additional income from reinvestment is the "interest on interest" component. There may be a risk that
the rate at which interim cash flows can be reinvested are lower than that originally assumed.