What does inflation risk potentially impact for bond investors?

Inflation risk specifically refers to the potential for inflation to erode the purchasing power of money over time. For bond investors, this means that the fixed interest payments received from their bonds may not maintain their real value in the context of rising prices. As inflation increases, each dollar received in interest payments buys fewer goods and services, diminishing the overall purchasing power of the returns on the bond.

Understanding this concept is crucial for bond investors, as it highlights the importance of looking beyond nominal returns. If inflation rates surpass the interest rates offered by bonds, the real return (i.e., the return adjusted for inflation) can become negative, resulting in a loss of purchasing power. This is a critical consideration when evaluating investments in fixed-income securities, especially during periods of rising inflation.

The other options do not directly relate to what inflation risk encompasses: bond liquidity pertains to how easily a bond can be bought or sold in the market, credit quality relates to the risk of default by the bond issuer, and interest rate fluctuations may affect bond prices but are distinct from inflationary impacts on purchasing power.