Why bond prices move at all
A bond is a fixed promise. That is the whole reason its price has to move.
Suppose you hold a bond paying ₹70 a year on a face value of ₹1,000 — a 7% coupon. Rates then rise, and new bonds of similar quality are issued paying 8%. Your bond still pays ₹70, because that was the promise.
Nobody will now pay ₹1,000 for ₹70 a year when ₹1,000 elsewhere buys ₹80 a year. So the price of your bond falls until the ₹70 represents a competitive return on the lower price. The coupon never changed; the price did all the adjusting.
That is the entire mechanism. Rates up, prices down; rates down, prices up — and since debt funds mark holdings to market daily, it appears in NAV immediately.
How much prices move: the role of time
Two bonds, both paying 7%, both now competing with 8% issues. One matures next year; one matures in fifteen.
The one-year bond is uncompetitive for one more year, then repays face value. The shortfall is small and brief, so its price barely moves. The fifteen-year bond is uncompetitive for fifteen more years, so a much larger total shortfall has to be discounted into today's price, and the price falls much further.
The longer the remaining life, the more the price moves for the same change in rates. Duration is the formalisation of that idea.
Two durations, and which one you use
| What it is | Used for | |
|---|---|---|
| Macaulay duration | The weighted average time until you receive the bond's cashflows, in years | Defining SEBI's debt fund categories |
| Modified duration | The percentage price change for a one-percentage-point change in yield | Estimating what a rate move will actually cost you |
Macaulay duration is the one the category rules are written in, which is why it appears in scheme documents. Modified duration is the one to read, because it is denominated in the thing you care about.
The one line of arithmetic
Approximate percentage change in value = − modified duration × change in yield (in percentage points).
| Fund's modified duration | If yields rise 1 pt | If yields fall 1 pt | Typical of |
|---|---|---|---|
| 0.3 | ≈ −0.3% | ≈ +0.3% | Liquid and overnight funds |
| 1.5 | ≈ −1.5% | ≈ +1.5% | Short-dated funds |
| 4.0 | ≈ −4.0% | ≈ +4.0% | Medium to long funds |
| 8.0 | ≈ −8.0% | ≈ +8.0% | Long-dated gilt funds |
Two things this table makes obvious that a category name does not. A long gilt fund carrying no meaningful credit risk can still fall 8% on a one-point rate move — “government backed” protects against default, not against rates. And the same move that hurts a long fund helps it symmetrically when rates fall, which is why long-duration funds behave like a rate view rather than like a savings product.
Two caveats. The relationship is not perfectly linear for large moves — the curvature is called convexity, and it works slightly in a holder's favour. And the yields on different maturities do not move together, so a one-point shift everywhere is a simplification.
The offsetting force: accrual
A price fall is not the whole picture, because the fund is also earning interest every day.
Rough intuition: a fund with modified duration of 4 and a yield to maturity of around 7% takes roughly a 4% hit from a one-point rise, against roughly 7% of accrual over a year. Hold through it and accrual can absorb the price move. Sell into it and you have taken the price loss without collecting the accrual that was going to repair it.
Which is the practical reason duration risk is far more dangerous to a short holder than a long one, and why the horizon question comes before the fund question.
Matching duration to your horizon
The single most useful thing to do with duration is match it, roughly, to how long you intend to stay invested.
Hold for approximately the fund's duration and the price effects of rate moves substantially wash out — a fall now is offset by higher reinvestment yields afterwards, and vice versa. Your outcome converges towards the yield you started with. Hold for far less than the duration and you are exposed to whatever rates did in the meantime, which is a bet you probably did not intend to place.
Stated as a rule of thumb: money needed soon belongs in a low-duration fund, even if a longer one is yielding more. The extra yield on the longer fund is payment for accepting rate risk over a period you do not have.
Reading YTM alongside it
Yield to maturity is the return the current portfolio would deliver if every holding paid as promised and nothing was traded. Net of the expense ratio, it is a reasonable indication of what a fund is positioned to earn.
It is an indication, not a promise, and it assumes no defaults. So a YTM sitting clearly above category peers is not evidence of a better manager — it is usually evidence of lower-rated holdings, which is a statement about credit risk rather than skill.
Read together: duration tells you what rates can do to you, YTM tells you what you are being paid, and the credit breakdown tells you how much of that payment is compensation for risk of not being repaid.
Finding these numbers
Modified duration, Macaulay duration and YTM are all in the monthly factsheet, and the rating breakdown is in the portfolio disclosure. Both are published by every fund house and neither is difficult to read once you know what the numbers do.
FNOTrader's Mutual Funds app holds the full AMFI NAV history — around 34 million NAV rows — so how a given debt fund actually behaved through past rate cycles can be inspected directly, which is a firmer basis than an estimate from duration alone. Formulas are published in the user guide.
Common questions
What is duration in a debt fund?
A measure of how sensitive the portfolio's value is to a change in interest rates. Modified duration is the usable form: it estimates the percentage change in value for a one-percentage-point change in yield.
How do I use modified duration?
Multiply it by the rate change you want to test. A fund with modified duration of 4 would lose roughly 4% of its value if yields rose one percentage point, and gain roughly 4% if they fell one. It is an approximation, and close enough for sizing.
Why do bond prices fall when interest rates rise?
Because a bond's coupon is a fixed promise. If new bonds are issued paying more, nobody will pay full price for the older, lower-paying one, so its market price falls until its effective yield matches the new going rate.
What is the difference between Macaulay and modified duration?
Macaulay duration is the weighted average time in years until the bond's cashflows are received, and it is what SEBI's debt category definitions are written in. Modified duration converts that into a percentage price change per one-point yield move, which is the form you actually use.
Are gilt funds safe?
They carry no meaningful credit risk, since the borrower is the government, but they are frequently long in duration — a long gilt fund can fall around 8% on a one-percentage-point rise in yields. Government backing protects against default, not against interest rates.
How long should I hold a debt fund?
Roughly matching the holding period to the fund's duration causes most of the price effect of rate moves to wash out, because a fall now is offset by higher reinvestment yields afterwards. Holding for far less than the duration leaves you exposed to whatever rates did in the meantime.
Is a higher YTM better?
Not by itself. YTM assumes every holding pays as promised, so a yield clearly above category peers usually reflects lower-rated holdings rather than better management — information about credit risk, not skill. Read it with the rating breakdown.
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