{"id":24418,"date":"2022-05-30T16:02:46","date_gmt":"2022-05-30T16:02:46","guid":{"rendered":"https:\/\/www.5paisa.com\/finschool\/?post_type=markets&#038;p=24418"},"modified":"2026-10-21T15:04:49","modified_gmt":"2026-10-21T09:34:49","slug":"debt-funds-part-1","status":"publish","type":"markets","link":"https:\/\/www.5paisa.com\/finschool\/course\/financial-planning-through-mutual-funds-course\/debt-funds-part-1\/","title":{"rendered":"Debt Funds Part 1"},"content":{"rendered":"\t\t<div data-elementor-type=\"wp-post\" data-elementor-id=\"24418\" class=\"elementor elementor-24418\">\n\t\t\t\t\t\t<section class=\"elementor-section elementor-top-section elementor-element elementor-element-e109529 elementor-section-full_width tab_container elementor-section-height-default elementor-section-height-default\" data-id=\"e109529\" data-element_type=\"section\">\n\t\t\t\t\t\t<div class=\"elementor-container elementor-column-gap-default\">\n\t\t\t\t\t<div class=\"elementor-column elementor-col-100 elementor-top-column elementor-element elementor-element-8f8437a\" data-id=\"8f8437a\" data-element_type=\"column\">\n\t\t\t<div class=\"elementor-widget-wrap elementor-element-populated\">\n\t\t\t\t\t\t<section class=\"elementor-section elementor-inner-section elementor-element elementor-element-0af0e8c elementor-section-full_width elementor-section-height-default elementor-section-height-default\" data-id=\"0af0e8c\" data-element_type=\"section\">\n\t\t\t\t\t\t<div class=\"elementor-container elementor-column-gap-wide\">\n\t\t\t\t\t<div class=\"elementor-column elementor-col-50 elementor-inner-column elementor-element elementor-element-6ca0a3d chapters_list\" data-id=\"6ca0a3d\" data-element_type=\"column\">\n\t\t\t<div class=\"elementor-widget-wrap elementor-element-populated\">\n\t\t\t\t\t\t<div class=\"elementor-element elementor-element-0ddba2d elementor-widget elementor-widget-shortcode\" data-id=\"0ddba2d\" data-element_type=\"widget\" data-widget_type=\"shortcode.default\">\n\t\t\t\t<div class=\"elementor-widget-container\">\n\t\t\t\t\t\t\t<div class=\"elementor-shortcode\">\t<script>\n\t\tjQuery(document).ready(function(){\n\t\t\tjQuery(\"#post_chapters a[href*='\" + location.pathname + \"']\")\n\t\t\t\t.addClass(\"current\")\n\t\t\t\t.attr(\"aria-current\", \"page\");\n\t\t})\n\t<\/script>\n\t<div class=\"desktop_chapters\"><div id=\"post_chapters\"><div class=\"post_chapters-heading\">Chapters<\/div><ul><li><i class=\"fa fa-chevron-right\" aria-hidden=\"true\"><\/i>&nbsp;&nbsp;&nbsp;<a href=\"https:\/\/www.5paisa.com\/finschool\/course\/financial-planning-through-mutual-funds-course\/introduction-to-mutual-funds\/\">Background and Orientation<\/a><\/li><li><i class=\"fa fa-chevron-right\" aria-hidden=\"true\"><\/i>&nbsp;&nbsp;&nbsp;<a href=\"https:\/\/www.5paisa.com\/finschool\/course\/financial-planning-through-mutual-funds-course\/personal-finance-math\/\">Personal Finance Math<\/a><\/li><li><i class=\"fa fa-chevron-right\" aria-hidden=\"true\"><\/i>&nbsp;&nbsp;&nbsp;<a href=\"https:\/\/www.5paisa.com\/finschool\/course\/financial-planning-through-mutual-funds-course\/money-today-vs-money-tommorrow\/\">Money Today vs Money Tommorrow<\/a><\/li><li><i class=\"fa fa-chevron-right\" aria-hidden=\"true\"><\/i>&nbsp;&nbsp;&nbsp;<a href=\"https:\/\/www.5paisa.com\/finschool\/course\/financial-planning-through-mutual-funds-course\/the-retirement-part-1\/\">The Retirement -Part 1<\/a><\/li><li><i class=\"fa fa-chevron-right\" aria-hidden=\"true\"><\/i>&nbsp;&nbsp;&nbsp;<a href=\"https:\/\/www.5paisa.com\/finschool\/course\/financial-planning-through-mutual-funds-course\/assumptions-in-retirement-planning\/\">Assumptions in Retirement Planning<\/a><\/li><li><i class=\"fa fa-chevron-right\" aria-hidden=\"true\"><\/i>&nbsp;&nbsp;&nbsp;<a href=\"https:\/\/www.5paisa.com\/finschool\/course\/financial-planning-through-mutual-funds-course\/understanding-stock-funds\/\">The Role of Mutual Funds in Modern Finance<\/a><\/li><li><i class=\"fa fa-chevron-right\" aria-hidden=\"true\"><\/i>&nbsp;&nbsp;&nbsp;<a href=\"https:\/\/www.5paisa.com\/finschool\/course\/financial-planning-through-mutual-funds-course\/concept-of-fund-and-nav\/\">Concept of Fund and NAV<\/a><\/li><li><i class=\"fa fa-chevron-right\" aria-hidden=\"true\"><\/i>&nbsp;&nbsp;&nbsp;<a href=\"https:\/\/www.5paisa.com\/finschool\/course\/financial-planning-through-mutual-funds-course\/understanding-the-performance-of-your-fund\/\">Mutual Fund Factsheet<\/a><\/li><li><i class=\"fa fa-chevron-right\" aria-hidden=\"true\"><\/i>&nbsp;&nbsp;&nbsp;<a href=\"https:\/\/www.5paisa.com\/finschool\/course\/financial-planning-through-mutual-funds-course\/the-equity-scheme\/\"> The Equity Scheme<\/a><\/li><li><i class=\"fa fa-chevron-right\" aria-hidden=\"true\"><\/i>&nbsp;&nbsp;&nbsp;<a href=\"https:\/\/www.5paisa.com\/finschool\/course\/financial-planning-through-mutual-funds-course\/know-your-fund-manager\/\">Equity Scheme Part 2<\/a><\/li><li><i class=\"fa fa-chevron-right\" aria-hidden=\"true\"><\/i>&nbsp;&nbsp;&nbsp;<a href=\"https:\/\/www.5paisa.com\/finschool\/course\/financial-planning-through-mutual-funds-course\/debt-funds-part-1\/\">Debt Funds Part 1<\/a><\/li><li><i class=\"fa fa-chevron-right\" aria-hidden=\"true\"><\/i>&nbsp;&nbsp;&nbsp;<a href=\"https:\/\/www.5paisa.com\/finschool\/course\/financial-planning-through-mutual-funds-course\/monitoring-your-portfolio\/\">Debt Funds Part 2<\/a><\/li><li><i class=\"fa fa-chevron-right\" aria-hidden=\"true\"><\/i>&nbsp;&nbsp;&nbsp;<a href=\"https:\/\/www.5paisa.com\/finschool\/course\/financial-planning-through-mutual-funds-course\/mutual-fund-myths\/\">Debt Funds Part 3<\/a><\/li><li><i class=\"fa fa-chevron-right\" aria-hidden=\"true\"><\/i>&nbsp;&nbsp;&nbsp;<a href=\"https:\/\/www.5paisa.com\/finschool\/course\/financial-planning-through-mutual-funds-course\/debt-funds-part-4\/\">Debt Funds Part 4<\/a><\/li><li><i class=\"fa fa-chevron-right\" aria-hidden=\"true\"><\/i>&nbsp;&nbsp;&nbsp;<a href=\"https:\/\/www.5paisa.com\/finschool\/course\/financial-planning-through-mutual-funds-course\/investing-in-bonds\/\">Investing in Bonds<\/a><\/li><\/ul><\/div><\/div><div class=\"chapters_toggle\"><a href=\"#\" id=\"open_chapters\" aria-label=\"View chapters\"><span>View Chapters<\/span>&nbsp;&nbsp;&nbsp;<i class=\"fa fa-chevron-right\" aria-hidden=\"true\"><\/i><\/a><a href=\"#\" id=\"close_chapters\" style=\"display:none;\" aria-label=\"Hide chapters\"><span>Hide Chapters<\/span>&nbsp;&nbsp;&nbsp;<i class=\"fa fa-chevron-right\" aria-hidden=\"true\"><\/i><\/a><\/div>\t<script>\n\t\tjQuery(document).ready(function(){\n\t\t\tjQuery('.chapters_toggle 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class=\"elementor-element elementor-element-8490e85 market_content_tabs elementor-widget elementor-widget-eael-adv-tabs\" data-id=\"8490e85\" data-element_type=\"widget\" data-widget_type=\"eael-adv-tabs.default\">\n\t\t\t\t<div class=\"elementor-widget-container\">\n\t\t\t\t\t        <div data-scroll-on-click=\"no\" data-scroll-speed=\"300\" id=\"eael-advance-tabs-8490e85\" class=\"eael-advance-tabs eael-tabs-horizontal eael-tab-auto-active \" data-tabid=\"8490e85\">\n            <div class=\"eael-tabs-nav \">\n                <ul class=\"eael-tab-inline-icon\" role=\"tablist\">\n                                            <li id=\"study\" class=\"active-default eael-tab-item-trigger eael-tab-nav-item\" aria-selected=\"true\" data-tab=\"1\" role=\"tab\" tabindex=\"0\" aria-controls=\"study-tab\" aria-expanded=\"false\">\n                            \n                                                                <i class=\"far fa-edit\"><\/i>                                                            \n                                                            <span class=\"eael-tab-title title-after-icon\" >Study<\/span>                            \n                                                    <\/li>\n                                            <li id=\"slides\" class=\" eael-tab-item-trigger eael-tab-nav-item\" aria-selected=\"false\" data-tab=\"2\" role=\"tab\" tabindex=\"-1\" aria-controls=\"slides-tab\" aria-expanded=\"false\">\n                            \n                                                                <i class=\"fas fa-book-open\"><\/i>                                                            \n                                                            <span class=\"eael-tab-title title-after-icon\" >Slides<\/span>                            \n                                                    <\/li>\n                                            <li id=\"videos\" class=\" eael-tab-item-trigger eael-tab-nav-item\" aria-selected=\"false\" data-tab=\"3\" role=\"tab\" tabindex=\"-1\" aria-controls=\"videos-tab\" aria-expanded=\"false\">\n                            \n                                                                <i class=\"far fa-eye\"><\/i>                                                            \n                                                            <span class=\"eael-tab-title title-after-icon\" >Videos<\/span>                            \n                                                    <\/li>\n                    \n                                  <\/ul>\n            <\/div>\n            \n            <div class=\"eael-tabs-content\">\n\t\t        \n                    <div id=\"study-tab\" class=\"clearfix eael-tab-content-item active-default\" data-title-link=\"study-tab\">\n\t\t\t\t        <p><div class='white' style='background:rgb(255, 255, 255); border:solid 0px rgb(255, 255, 255); border-radius:0px; padding:0px 0px 0px 1px;'>\n<div id='text_slider' class='owl-carousel sa_owl_theme owl-pagination-true' data-slider-id='text_slider' style='visibility: visible;visibility:visible;'>\n<div id='text_slider_slide01' class='sa_hover_container' data-hash='Understanding-the-Origins-of-Debt' style='padding:4.9% 5%; margin:0px 0%; background-color:rgb(255, 255, 255); min-height:405px; '><h2 style=\"text-align: left\"><strong>11.1 <\/strong><strong><b>Understanding the Origins of Debt<\/b><\/strong><\/h2>\r\n<p><img fetchpriority=\"high\" decoding=\"async\" class=\"aligncenter wp-image-77886 size-full\" src=\"https:\/\/www.5paisa.com\/finschool\/wp-content\/uploads\/2022\/05\/Understanding-the-Origins-of-Debt.png\" alt=\"Understanding the Origins of Debt\" width=\"1080\" height=\"1080\" srcset=\"https:\/\/www.5paisa.com\/finschool\/wp-content\/uploads\/2022\/05\/Understanding-the-Origins-of-Debt.png 1080w, https:\/\/www.5paisa.com\/finschool\/wp-content\/uploads\/2022\/05\/Understanding-the-Origins-of-Debt-300x300.png 300w, https:\/\/www.5paisa.com\/finschool\/wp-content\/uploads\/2022\/05\/Understanding-the-Origins-of-Debt-1024x1024.png 1024w, https:\/\/www.5paisa.com\/finschool\/wp-content\/uploads\/2022\/05\/Understanding-the-Origins-of-Debt-150x150.png 150w, https:\/\/www.5paisa.com\/finschool\/wp-content\/uploads\/2022\/05\/Understanding-the-Origins-of-Debt-768x768.png 768w, https:\/\/www.5paisa.com\/finschool\/wp-content\/uploads\/2022\/05\/Understanding-the-Origins-of-Debt-50x50.png 50w, https:\/\/www.5paisa.com\/finschool\/wp-content\/uploads\/2022\/05\/Understanding-the-Origins-of-Debt-100x100.png 100w, https:\/\/www.5paisa.com\/finschool\/wp-content\/uploads\/2022\/05\/Understanding-the-Origins-of-Debt-96x96.png 96w\" sizes=\"(max-width: 1080px) 100vw, 1080px\" \/><\/p>\r\n<p>Debt exists because individuals, businesses, and governments often need more money than they currently have to carry out important activities. When the available capital falls short, borrowing bridges the gap. This borrowed money creates a debt obligation\u00a0\u2014 a promise to repay with interest.<\/p>\r\n<p>Think of debt as a financial bridge: it connects today\u2019s limited resources with tomorrow\u2019s ambitions.<\/p>\r\n<p><strong><b>Personal Debt Example<\/b><\/strong><\/p>\r\n<p>Imagine you want to pursue a master\u2019s degree abroad. The total cost -tuition, living expenses, travel\u00a0 comes to \u20b940 lakh. You have saved \u20b910 lakh, but you still need \u20b930 lakh. To fill this gap, you approach a bank for an education loan.<\/p>\r\n<p>The bank checks your background, including your academic record and your parents\u2019 financial standing. If satisfied, it lends you the money. You now have a debt obligation: repay the loan in monthly installments over the next 7\u201310 years.<\/p>\r\n<p>Here, debt enables you to achieve something otherwise impossible \u2014 higher education abroad. But it also creates responsibility: regular repayments, interest costs, and the risk of default if you fail to repay.<\/p>\r\n<p><strong><b>Risks for the Lender<\/b><\/strong><\/p>\r\n<p>From the bank\u2019s perspective, lending is never risk-free. Several things can go wrong:<\/p>\r\n<ul>\r\n<li><b><\/b><strong><b>Cashflow risk<\/b><\/strong>: You may delay or skip installments, disturbing the bank\u2019s expected inflow.<\/li>\r\n<li><b><\/b><strong><b>Default risk<\/b><\/strong>: If you lose your job or face financial distress, repayment may stop altogether.<\/li>\r\n<li><b><\/b><strong><b>Interest rate risk<\/b><\/strong>: If market rates rise while your loan is at a fixed rate, the bank earns less than it could on newer loans (on a floating-rate loan, falling rates reduce the bank\u2019s income instead).<\/li>\r\n<li><b><\/b><strong><b>Credit rating risk<\/b><\/strong>: Your creditworthiness may deteriorate, increasing the chance of default.<\/li>\r\n<li><b><\/b><strong><b>Asset risk<\/b><\/strong>: If collateral\u00a0 loses value, the bank may struggle to recover its money.<\/li>\r\n<\/ul>\r\n<p>These risks explain why lenders scrutinize borrowers so carefully before approving loans.<\/p>\r\n<p><strong><b>Corporate Debt Example<\/b><\/strong><\/p>\r\n<p>Now scale this idea to a company. Suppose a renewable energy firm wants to build a solar power plant costing \u20b91,000 crore. It has \u20b9200 crore internally but needs \u20b9800 crore more.<\/p>\r\n<p>Two options exist:<\/p>\r\n<ol>\r\n<li><b><\/b><strong><b>Bank loan<\/b><\/strong>\u2013 The company borrows the entire \u20b9800 crore from a single bank.<\/li>\r\n<li><b><\/b><strong><b>Bond issuance<\/b><\/strong>\u2013 Instead of one lender, the company raises smaller amounts from thousands of investors. Large institutions might buy \u20b910 crore or more each, while individuals can buy bonds with a face value as low as \u20b910,000.<\/li>\r\n<\/ol>\r\n<p>In the second case, the company issues bonds\u00a0\u2014 formal promises to pay back principal plus periodic interest (called coupons). Bonds spread the risk across many investors rather than concentrating it in one bank.<\/p>\r\n<h3><strong><b>What is a Bond?<\/b><\/strong><\/h3>\r\n<p>A bond is essentially an IOU. The borrower (company or government) says: <em><i>\u201c<\/i><\/em>Lend me money today, and I\u2019ll pay you interest regularly plus return the full amount at maturity.\u201d<\/p>\r\n<p>For example, if the solar company issues a 10-year bond at 8% interest, investors receive annual coupon payments and get their principal back after 10 years. Bonds are tradable, meaning investors can sell them in the secondary market before maturity.<\/p>\r\n<p><strong><b>Risks in Bonds<\/b><\/strong><\/p>\r\n<p>Just like personal loans, bonds carry risks:<\/p>\r\n<ul>\r\n<li><b><\/b><strong><b>Credit risk<\/b><\/strong>: The company may fail to honor payments.<\/li>\r\n<li><b><\/b><strong><b>Interest rate risk<\/b><\/strong>: If rates in the economy rise, existing bonds with lower coupons lose value.<\/li>\r\n<li><b><\/b><strong><b>Price risk<\/b><\/strong>: Bond prices fluctuate in the market, so selling before maturity may lead to losses.<\/li>\r\n<\/ul>\r\n<p>These risks are why rating agencies like CRISIL or ICRA assign credit ratings to bonds, helping investors judge their safety.<\/p>\r\n<p><strong><b>Debt Funds Connection<\/b><\/strong><\/p>\r\n<p>Mutual funds step into this ecosystem by pooling investor money and buying bonds issued by companies, banks, or governments. As an investor, you don\u2019t directly lend to a company \u2014 instead, you invest in a debt fund, and the fund manager decides which bonds to buy.<\/p>\r\n<p>Your concerns as an investor are simpler:<\/p>\r\n<ul>\r\n<li>Which category of debt fund suits your goal?<\/li>\r\n<li>What risks are attached to that category?<\/li>\r\n<li>When should you invest?<\/li>\r\n<\/ul>\r\n<p>The fund manager worries about trading bonds, timing interest rates, and managing credit risk. You only need to understand the fund\u2019s purpose and suitability.<\/p>\r\n<p><strong><b>Why Debt Funds Matter<\/b><\/strong><\/p>\r\n<p>Debt funds are not just about returns; they serve multiple roles:<\/p>\r\n<ul>\r\n<li><b><\/b><strong><b>Relative stability <\/b><\/strong>for conservative investors (debt funds do not guarantee capital).<\/li>\r\n<li><b><\/b><strong><b>Liquidity <\/b><\/strong>through categories like liquid and overnight funds.<\/li>\r\n<li><b><\/b><strong><b>Diversification <\/b><\/strong>by balancing equity risk.<\/li>\r\n<li><b><\/b><strong><b>Steady income <\/b><\/strong>via coupon payments embedded in fund returns.<\/li>\r\n<\/ul>\r\n<p>Globally, the bond market is massive, and debt funds act as a gateway for retail investors to participate without directly buying bonds.<\/p>\r\n<p>&nbsp;<\/p>\r\n<p>&nbsp;<\/p>\r\n<p>&nbsp;<\/p>\r\n<p>&nbsp;<\/p>\r\n<p>&nbsp;<\/p>\r\n<p>&nbsp;<\/p><\/div>\n<div id='text_slider_slide02' class='sa_hover_container' data-hash='What-is-a-Liquid-Fund' style='padding:4.9% 5%; margin:0px 0%; background-color:rgb(255, 255, 255); min-height:405px; '><h2 style=\"text-align: left\"><strong>11.2. <b>What is a Liquid Fund<\/b><\/strong><\/h2>\r\n<p><img decoding=\"async\" class=\"aligncenter wp-image-77887 size-full\" src=\"https:\/\/www.5paisa.com\/finschool\/wp-content\/uploads\/2022\/05\/What-is-a-Liquid-Fund.png\" alt=\"What is a Liquid Fund\" width=\"1080\" height=\"1080\" srcset=\"https:\/\/www.5paisa.com\/finschool\/wp-content\/uploads\/2022\/05\/What-is-a-Liquid-Fund.png 1080w, https:\/\/www.5paisa.com\/finschool\/wp-content\/uploads\/2022\/05\/What-is-a-Liquid-Fund-300x300.png 300w, https:\/\/www.5paisa.com\/finschool\/wp-content\/uploads\/2022\/05\/What-is-a-Liquid-Fund-1024x1024.png 1024w, https:\/\/www.5paisa.com\/finschool\/wp-content\/uploads\/2022\/05\/What-is-a-Liquid-Fund-150x150.png 150w, https:\/\/www.5paisa.com\/finschool\/wp-content\/uploads\/2022\/05\/What-is-a-Liquid-Fund-768x768.png 768w, https:\/\/www.5paisa.com\/finschool\/wp-content\/uploads\/2022\/05\/What-is-a-Liquid-Fund-50x50.png 50w, https:\/\/www.5paisa.com\/finschool\/wp-content\/uploads\/2022\/05\/What-is-a-Liquid-Fund-100x100.png 100w, https:\/\/www.5paisa.com\/finschool\/wp-content\/uploads\/2022\/05\/What-is-a-Liquid-Fund-96x96.png 96w\" sizes=\"(max-width: 1080px) 100vw, 1080px\" \/><\/p>\r\n<p>Among all debt mutual funds, liquid funds are the most widely used because they serve a very practical purpose: parking money safely for short durations. By regulation, liquid funds can only invest in debt instruments that mature within 91 days\u00a0(residual maturity), and they must keep at least 20% in liquid assets such as cash, T-bills and government securities. This short maturity period ensures that the fund remains stable, low-risk, and highly liquid.<\/p>\r\n<p>Think of it as a financial \u201cwaiting room\u201d \u2014 a place where your money rests temporarily, earning better returns than a savings account, while still being available at short notice.<\/p>\r\n<p><strong><b>How Liquid Funds Work<\/b><\/strong><\/p>\r\n<p>Suppose Indian Oil Corporation\u00a0needs \u20b9500 crore to pay suppliers and manage day-to-day expenses. Instead of taking a long-term loan, it borrows for 60 days. It issues a short-term debt instrument promising repayment within that period, along with interest.<\/p>\r\n<p>Now imagine SBI Mutual Fund\u00a0has idle cash from investors. Seeing this opportunity, it invests \u20b9500 crore in Indian Oil\u2019s short-term paper. After 60 days, Indian Oil repays the principal plus interest.<\/p>\r\n<p>The interest quoted is always annualized. So if the coupon is 7% per year, the actual return for 60 days is calculated proportionally:<\/p>\r\n<p>Interest for 60 days\u00a0 = 60*7%\/365\u2248 1.15 %<\/p>\r\n<p>This way, the fund earns a small but steady return without locking money for long.<\/p>\r\n<p><strong><b>Types of Short-Term Instruments<\/b><\/strong><\/p>\r\n<p>Liquid funds invest in short-term money market instruments. Two of the most common are described below. In practice, bank certificates of deposit (CDs) often make up a large share of a liquid fund\u2019s portfolio, alongside TREPS (overnight lending backed by government securities):<\/p>\r\n<ul>\r\n<li><b><\/b><strong><b>Commercial Papers (CPs)<\/b><\/strong>: Issued by companies to meet working capital needs. For example, a telecom company may issue a 45-day CP to pay vendors.<\/li>\r\n<li><b><\/b><strong><b>Treasury Bills (T-Bills)<\/b><\/strong>: Issued by the Government of India to manage short-term cash requirements. These come in maturities of 91, 182, and 364 days.<\/li>\r\n<\/ul>\r\n<p>T-Bills are considered the safest because the government is virtually risk-free as a borrower. CPs, however, carry credit risk depending on the company\u2019s financial health.<\/p>\r\n<p><strong><b>Credit Risk and Coupon Rates<\/b><\/strong><\/p>\r\n<p>Imagine you are an investor with \u20b9100 crore to lend. Two borrowers approach you:<\/p>\r\n<ul>\r\n<li>A large FMCG company offering 6.5% interest.<\/li>\r\n<li>The Government of India offering the same 6.5%.<\/li>\r\n<\/ul>\r\n<p>You would naturally prefer the government because the risk of non-repayment is negligible. The FMCG company, despite being strong, carries some risk. To attract you, it must offer a higher coupon, say 7.5%.<\/p>\r\n<p>Now consider two companies:<\/p>\r\n<ul>\r\n<li><b><\/b><strong><b>Company X<\/b><\/strong>: Established for 30 years, profitable, strong balance sheet.<\/li>\r\n<li><b><\/b><strong><b>Company Y<\/b><\/strong>: A startup, only 5 years old, still stabilizing cash flows.<\/li>\r\n<\/ul>\r\n<p>If both offer 8%, you\u2019d choose Company X. For Company Y to raise funds, it must offer more \u2014 perhaps 10% \u2014 to compensate for the higher risk.<\/p>\r\n<p>This difference is captured by credit ratings, which work like a corporate version of an individual\u2019s credit score. Higher-rated companies borrow at lower rates; lower-rated ones must pay more.<\/p>\r\n<p><strong><b>Portfolio Composition of Liquid Funds<\/b><\/strong><\/p>\r\n<p>A liquid fund typically holds a mix of CDs, CPs, T-Bills and TREPS. T-Bills and TREPS provide safety and stability, while CPs and CDs add slightly higher returns but with some credit risk. The balance between government and corporate paper determines the fund\u2019s risk-return profile.<\/p>\r\n<p>For example, a conservative liquid fund may hold a larger share of T-Bills and TREPS and only top-rated CPs and CDs, while a more aggressive one may tilt towards papers of lower-rated companies to chase higher yields.<\/p>\r\n<p>&nbsp;<\/p>\r\n<p>&nbsp;<\/p>\r\n<p>&nbsp;<\/p>\r\n<p>&nbsp;<\/p>\r\n<p>&nbsp;<\/p><\/div>\n<div id='text_slider_slide03' class='sa_hover_container' data-hash='Purpose-of-Liquid-Funds' style='padding:4.9% 5%; margin:0px 0%; background-color:rgb(255, 255, 255); min-height:405px; '><h2 style=\"text-align: left\"><strong>11.3. <\/strong><strong><b>Purpose of Liquid Funds<\/b><\/strong><\/h2>\r\n<p><img decoding=\"async\" class=\"aligncenter wp-image-77888 size-full\" src=\"https:\/\/www.5paisa.com\/finschool\/wp-content\/uploads\/2022\/05\/Purpose-of-Liquid-Funds.png\" alt=\"Purpose of Liquid Funds\" width=\"1080\" height=\"1080\" srcset=\"https:\/\/www.5paisa.com\/finschool\/wp-content\/uploads\/2022\/05\/Purpose-of-Liquid-Funds.png 1080w, https:\/\/www.5paisa.com\/finschool\/wp-content\/uploads\/2022\/05\/Purpose-of-Liquid-Funds-300x300.png 300w, https:\/\/www.5paisa.com\/finschool\/wp-content\/uploads\/2022\/05\/Purpose-of-Liquid-Funds-1024x1024.png 1024w, https:\/\/www.5paisa.com\/finschool\/wp-content\/uploads\/2022\/05\/Purpose-of-Liquid-Funds-150x150.png 150w, https:\/\/www.5paisa.com\/finschool\/wp-content\/uploads\/2022\/05\/Purpose-of-Liquid-Funds-768x768.png 768w, https:\/\/www.5paisa.com\/finschool\/wp-content\/uploads\/2022\/05\/Purpose-of-Liquid-Funds-50x50.png 50w, https:\/\/www.5paisa.com\/finschool\/wp-content\/uploads\/2022\/05\/Purpose-of-Liquid-Funds-100x100.png 100w, https:\/\/www.5paisa.com\/finschool\/wp-content\/uploads\/2022\/05\/Purpose-of-Liquid-Funds-96x96.png 96w\" sizes=\"(max-width: 1080px) 100vw, 1080px\" \/><\/p>\r\n<p>Liquid funds are essentially short-term parking lots for money you don\u2019t want lying idle but also don\u2019t want locked away. Imagine you\u2019re a small business owner who has just received \u20b910 lakh from a client. You know you\u2019ll need to pay suppliers in about two months. Keeping this money in a savings account feels wasteful because the returns are minimal. A liquid fund allows you to earn a slightly better return while still keeping the money accessible when the time comes.<\/p>\r\n<p>Think of it like parking your car in a safe, monitored lot instead of leaving it on the street. You\u2019re not planning a long road trip (that would be equity or long-term debt funds), but you want the car secure and ready to drive whenever needed.<\/p>\r\n<p><strong><b>Liquid Fund vs Savings Account<\/b><\/strong><\/p>\r\n<p>The natural question is: why not just leave the money in a savings account? The answer lies in the return differential. Savings accounts at most large banks in India offer about 2.5\u20133% interest. Liquid funds have recently delivered roughly 5.5\u20136.5% a year, moving in line with short-term interest rates (the RBI raised its repo rate from 5.25% to 5.50% on 7 October 2026, and liquid fund yields tend to follow such moves). That difference may sound small, but on larger sums, it adds up. For example, \u20b910 lakh in a savings account might earn \u20b925,000\u201330,000 in a year, while a liquid fund could generate \u20b955,000\u201365,000. Both are taxed at your income-tax slab rate.<\/p>\r\n<p>That extra \u20b930,000 or so could cover your annual car insurance or a family vacation. So, while the difference isn\u2019t life-changing, it\u2019s meaningful enough for people who want their money to work harder without losing accessibility.<\/p>\r\n<p><strong><b>The Risk Factor<\/b><\/strong><\/p>\r\n<p>Here\u2019s the catch: liquid funds are not risk-free. They invest in instruments like <strong><b>commercial papers (CPs)<\/b><\/strong>\u00a0issued by companies, <strong><b>treasury bills (T-bills)<\/b><\/strong>\u00a0issued by the government, and short-term corporate bonds or certificates of deposit maturing within 91 days. While government securities are virtually risk-free thanks to sovereign backing, CPs carry credit risk.<\/p>\r\n<p>For instance, imagine a liquid fund holds CPs issued by a large retail chain. If that chain suddenly faces financial trouble and its credit rating is downgraded, the value of those CPs drops. This directly impacts the fund\u2019s NAV (Net Asset Value), meaning investors could see their capital shrink overnight.<\/p>\r\n<p><strong><b>Real-World Example of Risk<\/b><\/strong><\/p>\r\n<p>A dramatic case occurred in 2017 when Taurus AMC\u2019s liquid fund lost nearly 7% in a single day. The reason? The fund had invested heavily in CPs issued by Ballarpur Industries. When rating agencies downgraded Ballarpur\u2019s papers, the NAV collapsed. Investors who thought their money was \u201csafe\u201d suddenly saw losses. Since then, SEBI has tightened the rules: liquid funds must hold at least 20% in liquid assets, can invest only in listed commercial papers, must value their holdings at market prices, and can ring-fence a defaulted or downgraded paper in a separate \u201cside pocket.\u201d Liquid funds also charge a small graded exit load on units redeemed within the first six days of investment.<\/p>\r\n<p>This shows that while liquid funds are marketed as \u201cbetter than savings accounts or fixed deposits,\u201d they are not substitutes. Bank savings accounts and FDs pay a fixed interest rate and are insured by DICGC up to \u20b95 lakh per depositor per bank. Liquid funds, though relatively safe, still carry market-linked risks.<\/p>\r\n<p><strong><b>How to Choose Wisely<\/b><\/strong><\/p>\r\n<p>If you decide to invest in liquid funds, the key is to look at the portfolio composition. A fund with a higher share of government securities or treasury bills is safer than one loaded with corporate CPs. For example, if Fund A has 70% government securities and Fund B has 70% corporate CPs, Fund A is the safer bet, even if Fund B promises slightly higher returns.<\/p>\r\n<p>It\u2019s like choosing between two parking lots: one is guarded by the government, the other by private security. Both may be fine, but the government-backed lot gives you more peace of mind.<\/p>\r\n<p>&nbsp;<\/p>\r\n<p>&nbsp;<\/p>\r\n<p>&nbsp;<\/p>\r\n<p>&nbsp;<\/p>\r\n<p>&nbsp;<\/p>\r\n<p>&nbsp;<\/p><\/div>\n<div id='text_slider_slide04' class='sa_hover_container' data-hash='Key-Takeaways' style='padding:4.9% 5%; margin:0px 0%; background-color:rgb(255, 255, 255); min-height:405px; '><h2 style=\"text-align: left\"><strong>11.4 Key Takeaways<\/strong><\/h2>\r\n<p><img loading=\"lazy\" decoding=\"async\" class=\"aligncenter wp-image-76118 size-full\" src=\"https:\/\/www.5paisa.com\/finschool\/wp-content\/uploads\/2022\/01\/Key-Takeaways-4.png\" alt=\"Key Takeaways\" width=\"444\" height=\"418\" srcset=\"https:\/\/www.5paisa.com\/finschool\/wp-content\/uploads\/2022\/01\/Key-Takeaways-4.png 444w, https:\/\/www.5paisa.com\/finschool\/wp-content\/uploads\/2022\/01\/Key-Takeaways-4-300x282.png 300w, https:\/\/www.5paisa.com\/finschool\/wp-content\/uploads\/2022\/01\/Key-Takeaways-4-50x47.png 50w, https:\/\/www.5paisa.com\/finschool\/wp-content\/uploads\/2022\/01\/Key-Takeaways-4-100x94.png 100w, https:\/\/www.5paisa.com\/finschool\/wp-content\/uploads\/2022\/01\/Key-Takeaways-4-150x141.png 150w\" sizes=\"(max-width: 444px) 100vw, 444px\" \/><\/p>\r\n<ul>\r\n<li>Liquid funds are ideal for short-term parking of spare cash.<\/li>\r\n<li>They offer better returns than savings accounts, but not without risk.<\/li>\r\n<li>They are not substitutes for FDs or savings accounts, which offer fixed returns and deposit insurance.<\/li>\r\n<li>Always check the portfolio mix\u2014funds with more government securities are safer.<\/li>\r\n<li>Use liquid funds for money you may need within about three months, not for long-term wealth creation. For three to twelve months, the ultra-short and money market categories in Chapters 12 and 13 usually fit better.<\/li>\r\n<\/ul>\r\n<p>Liquid funds are only the first step on the debt fund ladder. In the next chapter, we look at what actually drives a debt fund\u2019s returns: how bond prices react to interest rates, what Macaulay and modified duration measure, and how SEBI arranges the debt fund categories by duration and risk.<\/p>\r\n<p>&nbsp;<\/p>\r\n<p>&nbsp;<\/p>\r\n<p>&nbsp;<\/p><\/div>\n<\/div>\n<\/div>\n<script type='text\/javascript'>\n\tjQuery(document).ready(function() {\n\t\tjQuery('#text_slider').owlCarousel({\n\t\t\titems : 1,\n\t\t\tsmartSpeed : 400,\n\t\t\tautoplay : false,\n\t\t\tautoplayHoverPause : false,\n\t\t\tsmartSpeed : 400,\n\t\t\tfluidSpeed : 400,\n\t\t\tautoplaySpeed : 400,\n\t\t\tnavSpeed : 400,\n\t\t\tdotsSpeed : 400,\n\t\t\tdotsEach : 1,\n\t\t\tloop : false,\n\t\t\tnav : true,\n\t\t\tnavText : ['Previous','Next'],\n\t\t\tdots : true,\n\t\t\tresponsiveRefreshRate : 200,\n\t\t\tslideBy : 1,\n\t\t\tmergeFit : true,\n\t\t\tautoHeight : true,\n\t\t\tmouseDrag : false,\n\t\t\ttouchDrag : true\n\t\t});\n\t\tjQuery('#text_slider').css('visibility', 'visible');\n\t\tvar owl_goto = jQuery('#text_slider');\n\t\tjQuery('.text_slider_goto1').click(function(event){\n\t\t\towl_goto.trigger('to.owl.carousel', 0);\n\t\t});\n\t\tjQuery('.text_slider_goto2').click(function(event){\n\t\t\towl_goto.trigger('to.owl.carousel', 1);\n\t\t});\n\t\tjQuery('.text_slider_goto3').click(function(event){\n\t\t\towl_goto.trigger('to.owl.carousel', 2);\n\t\t});\n\t\tjQuery('.text_slider_goto4').click(function(event){\n\t\t\towl_goto.trigger('to.owl.carousel', 3);\n\t\t});\n\t\tvar resize_24096 = jQuery('.owl-carousel');\n\t\tresize_24096.on('initialized.owl.carousel', function(e) {\n\t\t\tif (typeof(Event) === 'function') {\n\t\t\t\twindow.dispatchEvent(new Event('resize'));\n\t\t\t} else {\n\t\t\t\tvar evt = window.document.createEvent('UIEvents');\n\t\t\t\tevt.initUIEvent('resize', true, false, window, 0);\n\t\t\t\twindow.dispatchEvent(evt);\n\t\t\t}\n\t\t});\n\t});\n<\/script>\n<\/p>                    <\/div>\n\t\t        \n                    <div id=\"slides-tab\" class=\"clearfix eael-tab-content-item \" data-title-link=\"slides-tab\">\n\t\t\t\t        <p><img decoding=\"async\" class=\"aligncenter\" src=\"https:\/\/www.5paisa.com\/finschool\/wp-content\/uploads\/2021\/10\/coming-soon-person-g8026473a8_1920-removebg-preview.png\" \/><\/p>                    <\/div>\n\t\t        \n                    <div id=\"videos-tab\" class=\"clearfix eael-tab-content-item \" data-title-link=\"videos-tab\">\n\t\t\t\t        <p><img decoding=\"async\" class=\"aligncenter\" src=\"https:\/\/www.5paisa.com\/finschool\/wp-content\/uploads\/2021\/10\/coming-soon-person-g8026473a8_1920-removebg-preview.png\" \/><\/p>                    <\/div>\n\t\t                    <\/div>\n        <\/div>\n\t\t\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t\t\t\t<\/div>\n\t\t<\/div>\n\t\t\t\t\t<\/div>\n\t\t<\/section>\n\t\t\t\t\t<\/div>\n\t\t<\/div>\n\t\t\t\t\t<\/div>\n\t\t<\/section>\n\t\t\t\t<\/div>\n\t\t","protected":false},"excerpt":{"rendered":"<p>Study Slides Videos 11.1 Impact of Expenses &nbsp; Ask your neighbour how much she pays for cable television service every month and she can probably tell you within a rupee. Ask her how much she pays for money management and she might not have any idea. Yet, she\u00e2\u20ac\u2122s probably paying five times more for money &#8230; <a title=\"Debt Funds Part 1\" class=\"read-more\" href=\"https:\/\/www.5paisa.com\/finschool\/course\/financial-planning-through-mutual-funds-course\/debt-funds-part-1\/\" aria-label=\"Read more about Debt Funds Part 1\">Read more<\/a><\/p>\n","protected":false},"author":1,"featured_media":0,"parent":11088,"menu_order":11,"comment_status":"closed","ping_status":"closed","template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[],"class_list":["post-24418","markets","type-markets","status-publish","format-standard","hentry"],"acf":[],"_links":{"self":[{"href":"https:\/\/www.5paisa.com\/finschool\/wp-json\/wp\/v2\/markets\/24418","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.5paisa.com\/finschool\/wp-json\/wp\/v2\/markets"}],"about":[{"href":"https:\/\/www.5paisa.com\/finschool\/wp-json\/wp\/v2\/types\/markets"}],"author":[{"embeddable":true,"href":"https:\/\/www.5paisa.com\/finschool\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/www.5paisa.com\/finschool\/wp-json\/wp\/v2\/comments?post=24418"}],"version-history":[{"count":11,"href":"https:\/\/www.5paisa.com\/finschool\/wp-json\/wp\/v2\/markets\/24418\/revisions"}],"predecessor-version":[{"id":77889,"href":"https:\/\/www.5paisa.com\/finschool\/wp-json\/wp\/v2\/markets\/24418\/revisions\/77889"}],"up":[{"embeddable":true,"href":"https:\/\/www.5paisa.com\/finschool\/wp-json\/wp\/v2\/markets\/11088"}],"wp:attachment":[{"href":"https:\/\/www.5paisa.com\/finschool\/wp-json\/wp\/v2\/media?parent=24418"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.5paisa.com\/finschool\/wp-json\/wp\/v2\/categories?post=24418"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}