Default risk refers to the chances that a borrower will fail to pay its financial obligations under a contract. For instance, if a person who has taken a home loan from a bank fails to make monthly payment of EMIs, we say the customer has defaulted in his payment obligations. The bank is prone to default risk, or risk of its customers failing to make timely payment of its loans.
In case of a bond, which is a debt obligation for the bond issuer, the borrower (bond issuer) can get into a situation where it is unbale to make periodic interest payments or is unbale to return the principal to the bond holders when the bonds mature. If such a scenario occurs, it is said that the bond issuer has defaulted. When investors invest their money in bonds issued by various entities, they are subject to default risk i.e. the likelihood of the bond issuer defaulting in its payments.
Within a Mutual Fund scheme, there are three options to grow your money, namely growth, dividend reinvest and dividend payout. In case of Dividend Reinvestment option, you can reinvest the dividend made by the scheme during the intermediate period back into the scheme. A Mutual Fund scheme invests in a basket of securities like stocks, bonds, gold and even international securities. Some of these securities pay dividends while others may pay interest, while some others may pay bonus. The profits made by the scheme in the form of dividends, interests, gains or bonus can be distributed among the scheme’s investors at the discretion of the fund managers. Fund managers decide when to distribute profits from the scheme among investors.
If a fund manager does decide to distribute the profits, the declared profits in the form of dividends are not paid to investors when they opt for dividend reinvest option but are rather reinvested in buying more units of the fund. Unlike a growth option where the value or NAV of your holding grows, here the number of units held by you grows since the dividend amount is used to buy more units of the scheme.
In case of Dividend Payout option, you receive any dividend declared by the companies included in the portfolio of your scheme. Within dividend option, you can either choose to receive the dividend payouts or reinvest the declared dividend back into the scheme. Dividend Payout options lets you receive any profit/surplus declared by the scheme during the time you remain invested in the scheme. Dividend payout option provides a regular cashflow, though there is no guarantee that the scheme will continue to pay you dividend always at regular intervals.
A Mutual Fund scheme invests in a basket of securities like stocks, bonds, gold and even international securities. Some of these securities pay dividends while others may pay interest while some others may pay bonus. The profits/surplus made by the scheme in the form of dividends, interests, gains or bonus can be distributed among the scheme’s investors at the discretion of the fund managers. Fund managers decide when to distribute profits from the scheme among investors. In case of dividend payout option, you will receive the profits made by the scheme whenever the fund manager decides to distribute this profit among investors. The NAV of a dividend scheme falls to the extent of dividend declared on the ex-dividend date i.e. the next business day after the dividend has been declared.
The dividends may stop coming if the scheme makes a loss at any time, or if the fund manager decides to reinvest the profit back into the scheme by buying more assets.