Why do returns from debt / income mutual funds fluctuate from period to period despite them being invested in fixed interest instruments?

The returns differ from year to year on account of the following reasons: An income fund invests in instruments from which it earns two kinds of returns - The first comes from interest income. The second comes from any increase in the market price of invested instruments. The second component could also be negative when there is a fall in the market value of the invested instruments. The rise and fall in market prices of debt instruments is a function of the prevailing interest rates. Thus changes in interest rate environment cause fluctuations in returns. Secondly, income mutual funds invest in an array of instruments with different maturity. Whenever any debt instrument in which the fund has invested is redeemed, the redemption proceeds have to be reinvested in a fresh instrument(s). This fresh investment would earn a rate of return depending on the prevailing interest rate, which could be higher or lower than that prevailing in the earlier period. Accordingly, the overall return ...  more