Concept
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As we have seen, credit risk is reflected in market prices, so credit risk and interest-rate risk seem related. One approach is to define market risk more inclusively, whereby it includes both layers of price variation described above. It is an essentially equivalent approach to view market/interest- rate risk as the variation in non-default-able bond prices (or interest rates), and to view credit risk as something separate. In either approach, the conceptual separation is important (and comparing to government bonds helps to make this separation).
The crucial feature of bond investments is the fixed nature of their future payments — although one cannot know the value before maturity, or be sure that the issuer won’t default, one can be sure of the par value amount. However, one cannot be sure how much this amount will purchase at the future maturity date, because general prices tend to increase due to inflation. If prices increase faster than expected, the par value will have less purchasing power, exposing the bond-holder to added risk and uncertainty known as inflation risk. We can phrase this using economic jargon by saying that the par value is known in nominal terms, but not in real terms (we know the amount itself, but not how much it will actually be able to purchase).
A bond investment can also exhibit liquidity risk, meaning that it can be difficult to convert one’s investment to cash. The main way this can arise is if there are a relatively low number of participants in bond markets. Bonds issued by the United States government have so many potential investors that one can always find a buyer if one wishes to liquidate an investment. Bonds issued by a small company might not attract the interest of many investors, and one might be unable to sell these bonds at a price that suitably accounts for the involved market, credit and inflation risk. You might have to lower the price further (to induce a buyer to enter the market) or wait until buyers present themselves. Both of these are manifestations of liquidity risk. The longer the term of bonds (relative to money-market instruments), the more relevant this factor will be: if waiting until maturity is a matter of years rather than months, an investor might have to face an illiquid market if they need money in the near term.
Finally, an investor with any international concerns can face currency risk when investing in bonds. The known par value is given in a certain currency, but how this will convert to other currencies is uncertain. A government might have the authority to have their own currency printed, but they certainly cannot do so in foreign currencies (and indeed, a government default, or a country’s economic difficulties, can make their currency depreciate). An investor might not be concerned with the value of their investment in other currencies, but if they are (risk can depend greatly on the context), currency risk can be a relevant factor in a bond investment.