What role does credit risk play in bond investing?

In the context of bond investing, credit risk is fundamentally tied to the issuer's ability to meet its debt obligations. This risk directly influences the likelihood of default, which occurs when an issuer is unable to make interest payments or repay the principal on the bond.

When investors evaluate bonds, they assess the creditworthiness of the issuer, which can range from corporate entities to government issuers. Higher perceived credit risk typically leads to higher yields on those bonds since investors demand a premium for taking on additional risk. Thus, an accurate assessment of credit risk is essential for understanding the potential returns and risks associated with a bond investment.

The other options either misrepresent the scope of credit risk or the types of bonds affected. For instance, credit risk is a consideration for all types of bonds, not solely corporate or government bonds, and it affects the overall bond market's liquidity as higher credit risk can lead to wider bid-ask spreads and lower trading volumes. Therefore, recognizing credit risk as a determinant of default probability is crucial for informed decision-making in bond investing.