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nism-series-va-interest-rate-risk-hierarchy-debt-schemes[ MUTUAL FUND DISTRIBUTORS ]

Assuming similar credit quality, which of the following sequences correctly arranges debt mutual fund categories in increasing order of interest rate risk (from lowest duration risk to highest duration risk)?

[ A ]Long Duration Fund -> Medium Duration Fund -> Short Duration Fund -> Liquid Fund -> Overnight Fund

[ B ]Overnight Fund -> Liquid Fund -> Ultra Short Duration Fund -> Short Duration Fund -> Medium Duration Fund -> Long Duration Fund[ CORRECT ]

[ C ]Gilt Fund with 10-year constant maturity -> Overnight Fund -> Money Market Fund

[ D ]Credit Risk Fund -> Banking & PSU Debt Fund -> Liquid Fund -> Overnight Fund

Takeaway

Option B is correct: Overnight Fund -> Liquid Fund -> Ultra Short Duration Fund -> Short Duration Fund -> Medium Duration Fund -> Long Duration Fund

Derivation

Interest rate risk in debt funds is directly proportional to the Macaulay duration / maturity of the portfolio. Holding credit risk constant, the ladder of increasing duration risk is: Overnight Fund (1 day) -> Liquid Fund (up to 91 days) -> Ultra Short Duration Fund (3-6 months) -> Low Duration (6-12 months) -> Money Market (up to 1 yr) -> Short Duration (1-3 yrs) -> Medium Duration (3-4 yrs) -> Medium to Long Duration (4-7 yrs) -> Long Duration (>7 yrs). Longer duration securities suffer greater price drops when interest rates rise. This tests duration risk hierarchy. The common trap is reversing the duration ladder.

Why the others fail

A — Long Duration Fund -> Medium Duration Fund -> Short Duration Fund -> Liquid Fund -> Overnight Fund

This sequence represents decreasing interest rate risk, beginning with the highest duration category (Long Duration).

C — Gilt Fund with 10-year constant maturity -> Overnight Fund -> Money Market Fund

10-year Gilt funds carry high interest rate sensitivity and have far higher duration risk than Overnight and Money Market funds.

D — Credit Risk Fund -> Banking & PSU Debt Fund -> Liquid Fund -> Overnight Fund

This option mixes credit risk categories with duration categories and does not follow a pure duration risk progression.