Which scenario illustrates high liquidity risk?

A scenario illustrating high liquidity risk is one where a firm relies heavily on borrowed capital. This reliance can lead to liquidity issues because the firm may have significant obligations to repay loans, which could strain its cash flow, especially during downturns or periods of decreased revenue. When a firm utilizes borrowed funds, it is often required to make regular interest payments and ultimately repay the principal amount, which can create pressure on its available cash reserves. If the firm encounters unexpected expenses or economic challenges, its ability to meet these obligations without liquidating assets or incurring additional debt can be severely compromised. Consequently, this situation increases the likelihood that the firm will struggle to maintain adequate liquidity, ultimately leading to higher liquidity risk.