Which type of risk involves the potential loss due to an issuer's inability to make future payments?

The correct answer, credit risk, refers to the potential loss that investors may experience when an issuer is unable to fulfill its financial obligations, such as making future payments on interest or principal. This type of risk is particularly relevant in the context of bonds and other debt securities, where the issuer's creditworthiness directly impacts the likelihood of receiving those payments. For instance, if a company faces financial difficulties or defaults, investors could suffer losses, making credit risk a critical consideration for those investing in fixed income securities.

Market risk, liquidity risk, and interest rate risk pertain to different aspects of investing. Market risk relates to the overall fluctuations in the financial markets that can affect all investments, regardless of the issuer's ability to pay. Liquidity risk involves the struggle to sell an investment at a fair price when necessary, devoid of the performance aspect of an issuer's ability to generate returns. Interest rate risk is connected to the impact of changes in interest rates on the value of investments, particularly bonds; rising interest rates can lower the value of existing bonds but do not specifically address the issuer's capacity to make payments. Understanding these distinctions highlights why credit risk is the focus in this context.