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I was guessing how we earn from debt funds. I know the underlying bonds pay back interest. But I want to know how exactly we earn from debt funds.

I know how NAV of the fund increases in decreasing interest rate cycle. This increases NAV of existing funds. I guess, repo rate and reverse repo rate also affect NAV.

Q1. Does change in NAV due to above reasons is also one of the ways fund unit holders earn?

Q2. Does interest earned on underlying bonds reflect on NAV? If yes, then how? If not, then how the interest on underlying bonds is paid back to fund customers/unitholders?

I currently hold growth debt funds which incur NAV changes as described above. Earlier I had invested in daily dividend reinvestment debt scheme. In this scheme, the dividend earned daily was reinvested in buying more units of the scheme. But, as long as I recall it correct, the NAV of this scheme remained same till I withdraw my money.

Q3. Does the NAV of daily dividend reinvestment schemes dont change due to above reasons?

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    As you found out there are two types: funds either use the dividends to buy more bonds (and then they are worth more because they have more bonds), or they give the dividends back to you.
    – user253751
    Nov 9, 2021 at 21:09

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Q1. Does change in NAV due to above reasons is also one of the ways fund unit holders earn?

Yes, when the interest rates fall, the price of the old bonds with higher coupon goes up.

Q2. Does interest earned on underlying bonds reflect on NAV? If yes, then how? If not, then how the interest on underlying bonds is paid back to fund customers/unitholders?

This varies from fund to fund. Some pay the interest income back, others use it to buy more bonds, just like equity schemes.

Q3. Does the NAV of daily dividend reinvestment schemes dont change due to above reasons?

There could be many reasons for no change in NAV, for ex - the fund manager might have kept the cash as a reserve. There is no single right answer to this.

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  • Q4. "Some pay the interest income back": As in dividend payout schemes? Q5. "others use it to buy more bonds": As in dividend reinvestment schemes? Q6. If yes to both Q4 and Q5, is dividend nothing but interest earned on bonds and not something else (for example in equities dividend from company has different meaning)?
    – Mahesha999
    Feb 2, 2022 at 9:28

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