Overview
Fixed income is not fixed outcome. A bond promises contractual cash flows, but its market value and realised return depend on interest rates, inflation, issuer credit, liquidity and reinvestment. This guide explains how government and corporate bonds are priced, why duration and credit spreads matter, and how portfolio construction changes risk.
A bond's upside is mostly promised in advance, so analysis belongs in the downside: cash coverage, covenant protection, refinancing calendar, recovery and whether the investor can sell before maturity without an unacceptable discount.
AssetsNest research desk
The Owl view
Fixed income promises a schedule, not a fixed outcome. Duration moves the mark, inflation changes purchasing power, and credit determines whether the promised cash ever arrives.
government-bond funds underperformed in 2025
Rate positioning, fees and portfolio construction can matter even when default risk is low.
Open source ↗composite-bond funds underperformed over 10 years
The category result argues for benchmark, duration and fee scrutiny rather than yield chasing.
Open source ↗Case file
April 2020Franklin Templeton wound up six debt schemes
The episode exposed a structural mismatch: an open-ended promise of redemptions sat above less-liquid credit holdings during stressed markets. Credit quality, position size, market depth and redemption behaviour interacted; none could be assessed in isolation.
Analyse the liquidity of the assets and the liquidity promised by the wrapper as one system.What the market often misses
- A high yield may be the market's estimate of loss, not an income opportunity.
- A government bond can lose market value through duration even when repayment is expected.
- Credit ratings address a slice of risk; they do not replace cash-flow and recovery analysis.
Questions before acting
- What happens to price if rates rise 100 basis points?
- How much recovery remains after senior claims and enforcement time?
- Can the investment meet redemptions without selling the least-liquid assets at distressed prices?
Topic 1 of 5
Bonds and G-Secs
A bond is a contractual claim for interest and principal. Government Securities (G-Secs) are issued by the Government of India, while corporate bonds depend on the issuing company’s capacity and willingness to pay.
The part that changes the answer
G-Secs generally remove corporate default analysis but retain interest-rate, inflation and market-price risk. Corporate bonds add credit spreads, covenants, security and recovery considerations. Seniority, collateral and documentation can matter as much as the issuer name.
Read the instrument terms, maturity, cash-flow schedule, call features, liquidity and tax treatment. Do not compare yields without comparing risk and duration.
A 7% ₹1 lakh bond pays ₹7,000 annually, but its market value can fall if comparable yields rise; principal certainty exists only at maturity and only if the issuer pays.
Identify issuer, seniority, security, coupon, maturity, call terms, tax and trading depth. For G-Secs, separate sovereign credit from duration and mark-to-market risk.
The investor treats 'fixed income' as fixed value, sells before maturity after rates rise, or buys a callable bond whose attractive coupon disappears when refinancing favours the issuer.
Topic 2 of 5
Yield and duration
Yield summarises a bond’s expected return under stated assumptions; duration estimates price sensitivity to interest-rate changes and the timing of cash flows.
The part that changes the answer
Yield to maturity assumes contractual payments and reinvestment conditions that may not occur. Modified duration approximates the percentage price change for a small yield change, while convexity improves the estimate for larger moves. Longer-duration bonds usually react more to rate changes.
Match duration to the investment horizon and liabilities. A high yield can be offset by price decline, default or reinvestment at lower rates.
A five-year duration implies an approximate 5% price fall for a 1 percentage-point yield rise before convexity; a 20-year bond can move far more than its coupon suggests.
Use modified duration, convexity and key-rate exposures; match cash-flow dates to liabilities rather than selecting the highest yield in a category.
Yield falls because credit or liquidity worsens, yet the investor attributes all price movement to interest rates and discovers that duration hedges do not cover spread widening.
Topic 3 of 5
Credit spreads
A credit spread is the extra yield over a reference government or low-risk curve that compensates for default, recovery, liquidity and uncertainty.
The part that changes the answer
Spreads can tighten even as absolute yields rise, or widen sharply during stress. Comparing raw spreads across maturities or structures can mislead; option-adjusted and duration-aware measures are more informative where relevant.
Ask whether the spread pays for expected loss, unexpected loss, illiquidity and complexity after fees and taxes.
An 8.5% corporate yield minus a 7.0% matched G-Sec yield gives a 150 bp spread; that spread must cover expected loss, liquidity, downgrade risk and uncertainty.
Compare spread with default probability × loss severity, covenant quality, issue liquidity and sector cycle. Use a maturity-matched government curve, not a convenient headline rate.
A wide spread is called extra income although most of it compensates for a correlated default or the inability to exit when the market is stressed.
Topic 4 of 5
Default and recovery
Default occurs when an issuer fails to meet contractual obligations or triggers specified credit events. Recovery is the value creditors ultimately receive after restructuring, enforcement and costs.
The part that changes the answer
Recovery depends on enterprise value, collateral, seniority, intercreditor terms, jurisdiction and time. Credit ratings express an opinion, not a guarantee, and can change after market prices have already moved.
Underwrite cash-flow coverage and downside value before focusing on yield. Model the time and cost of recovery, not only a recovery percentage.
A ₹100 bond with 4% default probability and 40% recovery has a rough one-year expected credit loss of ₹2.4 before timing and legal cost: 4% × ₹60.
Build enterprise-value recovery through the seniority waterfall; haircut collateral for enforcement time, prior liens, working-capital claims, taxes and sale costs.
Book collateral value is mistaken for cash recovery, or repeated amendments postpone default recognition while interest capitalises against a weakening asset base.
Topic 5 of 5
Bond ladders
A bond ladder spreads maturities across several dates so that principal is regularly returned and can be reinvested or used for planned needs.
The part that changes the answer
Ladders can reduce dependence on one reinvestment date and help match liabilities, but they do not eliminate credit concentration, mark-to-market volatility or inflation. A poorly diversified ladder can simply distribute the same issuer risk across years.
Build the ladder around cash needs, issuer diversification, liquidity and tax impact rather than equally spaced dates alone.
Splitting ₹5 lakh equally across one- to five-year maturities returns ₹1 lakh principal each year, reducing the need to predict one reinvestment date.
Map maturity cash to actual liabilities, diversify issuer and sector, model callable securities and keep reinvestment assumptions separate from current yield.
A ladder diversifies dates but not credit: five maturities from one stressed issuer can still fail together, and long rungs can be illiquid before maturity.
India lens
What Indian readers should test
Compare Indian bonds and debt funds on yield-to-maturity, modified duration, credit mix, concentration and exit mechanics. A bank deposit, government security and credit fund may all be called fixed income while carrying different failure modes.
Risk framework
What can go wrong?
01Interest-rate increases reducing market value
02Inflation eroding real returns
03Issuer default or downgrade
04Low secondary-market liquidity
05Call or reinvestment risk
06Concentration in one issuer or sector
Specific questions
Questions this guide can answer
Are G-Secs risk-free?
They are generally treated as free of domestic sovereign credit risk, but they still carry interest-rate, inflation, liquidity and market-price risk.
Why can a bond fund fall when it earns interest?
The market value of its bonds can decline when yields rise or credit spreads widen, offsetting accrued income.
Does a higher coupon mean a better bond?
No. Coupon is only one cash-flow term. Price, maturity, credit quality, seniority, liquidity and call features determine risk and expected return.
Primary sources & further reading
Dated facts are linked to their source. Hypothetical calculations are labelled illustrative.
S&P DJI — SPIVA India Year-End 2025↗SEBI — Franklin Templeton six-scheme winding-up release↗How AssetsNest researches and labels evidence →AssetsNest Investor Services — ARN 318691. This guide is educational and informational only. It is not personalised investment, legal or tax advice, an offer, recommendation or solicitation. Rules, products and taxation can change; verify current official documents before acting.