What does 'liquidity risk' refer to?

Liquidity risk specifically refers to the potential difficulty that an entity may face in meeting its short-term financial obligations due to an inability to convert assets into cash quickly enough or without incurring significant losses. In simple terms, it is about having enough cash or liquid assets to pay off short-term debts as they come due. This risk becomes particularly acute during financial distress or market downturns, where the inability to sell assets quickly can lead to insolvency or bankruptcy.

The other options encompass different types of risks. Investment loss pertains to the potential decline in the value of investments but does not focus on the immediate liquidity needs. Currency fluctuations relate to the exchange rate changes that can impact the value of international transactions and investments but are unrelated to liquidity directly. Long-term debt default involves the failure to meet long-term debt obligations and is usually associated with solvency rather than liquidity. In this context, the correct identification of liquidity risk encapsulates the essence of preparing for and managing timely financial obligations.