What does liquidity risk signify in financial terms?

Liquidity risk, in financial terms, pertains to the potential challenges a company or individual may face in quickly selling an asset without incurring a significant loss in value. It reflects the ability to convert assets into cash promptly and at a stable price. When liquidity risk is high, it may take longer to sell an asset, or the asset may have to be sold at a discount to market value, thereby resulting in a loss.

The correct answer emphasizes that liquidity risk is particularly about the convertibility of assets; if an asset cannot be sold quickly in the market, it can lead to problems in meeting obligations or financing needs. This concept is crucial for both businesses and investors as it affects cash management and strategic financial planning.

In contrast, while the other options address various types of risks—such as cash flow issues, losses from financial derivatives, and fluctuations in interest rates—they do not define liquidity risk as specifically as the correct answer does. Therefore, the emphasis on quick sales and potential losses associated with illiquid assets highlights the core essence of liquidity risk.