The depreciation in the value of the rupee and worsening condition of the fiscal deficit resulted in the increase in bond yields in the last financial year and especially in the past few months. Even the slightest change in the market factors can affect the bond prices and yields and impact the earnings of the debt fund investors.
What is a bond yield?
The Bond yield is the return that an investor earns from investing in a particular bond. The yield considers the market price of a bond and so it is different from the coupon rate, which considers the face value of the bond. The Yield to Maturity is the rate of interest earned by the bondholder on its maturity.
The relationship between the current yield and the coupon value is given as follows:
The higher the market price of a bond than the face value, lower will be the current yield when compared to the coupon rate
The lower the market price than the face value of a bond, higher is the current yield in comparison of coupon rate
In the case where the market price and the face value are equal the current yield from bonds will be equal to its coupon rate
What is the impact of rising yields on the debt investors?
The rising yield is a symbol of earning good returns from the investments made in the debt funds in the years to come.
The following is the impact of high current yields on the debt investors:
The high yields phase: When an investor invests in the debt funds during the high yield phase, they tend to profit from it in the years ahead. After hitting its peak, the yields are set to come down and during this transitional phase, the bond prices and the Net Asset Value go up considerably.
The low yield phase: When an investor enters in the debt fund during the low yield phase, the investors can expect to earn an average return on the long-term debt funds in the near future.
The long-term debt funds: The bond prices and yields are inversely related to each other. The rise in bond yields tends to make the investors of long-term debt vulnerable to duration risk. The falling price of the bonds has a drastic effect on the long-term debt funds and leads to its capital loss. The capital loss incurred during this low phase also has a negative effect on the returns on investment.
The short-term debt funds: The short-term debt investors derive their returns on investment from the coupon amount and avail the remaining returns from the bond prices. When compared to the long-term debt fund investors, the short-term debt fund investors have managed to earn a positive flow of returns in the past few months.
If you are a debt fund, you should try to rebalance your portfolio by redistributing your funds from the long-term debt funds to the short-term debt fund. To grasp a better understanding of the rising bond yields, get in touch with us.