Which type of risk reflects the relationship between investment returns and inflation rates?

The correct answer is purchasing power risk because this type of risk specifically pertains to the effect of inflation on the real value of investment returns. When inflation rises, the purchasing power of the money received from investments can decline, meaning that even if returns are nominally positive, the actual buying power of those returns may be less than expected. Consequently, the real value of future cash flows may diminish if inflation outpaces the investment's return, thereby impacting the investor’s ability to maintain their standard of living.

Understanding purchasing power risk is particularly important for long-term investors. It underscores the necessity of seeking investment returns that can at least match or exceed inflation, to ensure that the purchasing power of their savings is preserved over time. While other types of risk, such as market risk or specific risk, may affect investment returns, only purchasing power risk directly connects investment performance with changes in inflation and its effects on the real value or utility of those returns.