What does the term 'liquidity risk' refer to?

Liquidity risk specifically refers to the potential challenge of selling an asset quickly without incurring significant losses. In financial markets, not all assets can be easily converted to cash, especially during times of market stress or if the asset is not in high demand. For example, real estate may take longer to sell compared to stocks, and selling it quickly might require accepting a lower price, which represents a loss relative to its perceived value.

Understanding liquidity risk is crucial for investors because it affects the ability to access cash when needed. If an investor holds an asset that cannot be sold quickly at a fair market price, they might face a situation where they cannot meet financial obligations or take advantage of other investment opportunities.

The other options do not accurately capture the essence of liquidity risk. The risk of losing capital in a declining market addresses market risk, the risk of insufficient cash flow pertains to cash flow risk, and rising interest rates are typically associated with interest rate risk, all of which are different concepts within financial risk management.