What does liquidity risk refer to in financial contexts?

Liquidity risk in financial contexts specifically pertains to the possibility that an entity will be unable to meet its short-term financial obligations due to an inability to convert assets into cash quickly without a significant loss in value. In essence, it highlights the challenges that can arise when cash flow is insufficient to cover immediate liabilities, which can occur even if an organization is otherwise solvent and has ample long-term assets.

The concept emphasizes the importance of having sufficient liquid assets on hand or the ability to obtain cash when needed. For example, a company may have a lot of its value in investments or physical assets but still face liquidity risk if it cannot rapidly access cash to pay off debts or other short-term obligations.

Other options, while related to financial conditions, do not directly define liquidity risk. The risk of losing investment capital relates more to investment volatility or poor asset performance, price fluctuations in assets concern market risk, and the risk of bankruptcy refers to insolvency issues rather than specifically addressing liquidity challenges.