What does credit risk primarily involve?

Credit risk primarily involves the safety of principal, which refers to the risk that a borrower or issuer of a debt security will fail to make required payments, thereby jeopardizing the return of the original investment. When credit risk is high, there is a greater likelihood that the lender or investor will not receive back the full amount of their investment, or they may experience delayed payments. This is particularly critical for fixed-income securities like bonds, where the integrity of the principal investment is essential for assessing overall returns.

The other options relate to different types of risk: fluctuations in interest rates pertain to interest rate risk, which affects the value of bonds and other interest-sensitive investments; market price fluctuations relate to market risk, which involves changes in the value of an investment due to market conditions; and inflationary risks deal with the potential decrease in purchasing power over time. Understanding these distinctions helps in recognizing that while all these risks are important considerations in investing, credit risk specifically highlights concerns regarding the return of the principal amount invested.