Bond Price-Yield Relationship

The seesaw

A bond pays a fixed coupon. If newly issued bonds start paying more because rates have risen, your older, lower-coupon bond looks less attractive, so its price must fall until its effective yield matches the market. The reverse is also true. This inverse link between price and yield is the single most important idea in fixed income.

When the RBI cuts the repo rate, fresh bonds carry lower coupons, making existing higher-coupon bonds more valuable, so their prices rise and yields drop.

Duration: how hard the seesaw tilts

Not every bond reacts equally. The longer a bond's maturity, the more its price swings for a given change in rates, a sensitivity captured by duration. A long-dated gilt fund can gain or lose sharply on rate moves, while an overnight or money-market fund barely flinches.

This is why during India's 2025 rate-cut cycle the picture was not simple. The RBI cut the repo rate by a cumulative 125 basis points to 5.50%, yet long-end G-Sec yields actually climbed, pushed up by heavy government borrowing. Long-duration debt funds saw outflows while short-duration and money-market funds drew strong inflows as investors avoided duration risk.

What it means for your debt fund

If you hold a debt mutual fund, this relationship explains why its NAV can fall even though it never defaults: rising market yields mark down the bonds it holds. A rate-cut environment can lift NAVs, but only if yields actually fall, which depends on supply, inflation expectations and fiscal pressures, not just the RBI's headline rate.

The practical takeaway is to match duration to your horizon. Reach for long duration only if you can ride out the volatility; otherwise short-duration funds give you most of the yield with far less price risk.