Liquidity Risk is the risk that an entity is unable to pay back its liabilities in a timely manner.

Liquidity Risk is the risk that an entity is unable to pay back its liabilities in a timely manner.

• A. The risk that an asset's price will fall due to market forces
• B. The risk that an entity cannot pay its liabilities in a timely manner
• C. The risk of inflation eroding purchasing power
• D. The risk of regulatory penalties affecting cash flow

Answer: (B)

Liquidity risk is about whether an entity can meet its short-term obligations with cash or assets that can be quickly turned into cash. The statement given matches this idea exactly: if you can’t pay liabilities in a timely manner, you’re facing liquidity risk because cash flow or the ability to convert assets to cash when needed is impaired. This risk is different from market risk, which concerns how asset prices move due to market forces and may affect value but not necessarily the ability to pay bills on time. It’s also different from inflation risk, which is about loss of purchasing power over time rather than the immediacy of cash obligations. Regulatory risk relates to penalties, fines, or changes in rules that can influence cash flow, but the core issue of liquidity focuses on having enough cash now or quickly deployable assets to meet payables.

Liquidity risk is about whether an entity can meet its short-term obligations with cash or assets that can be quickly turned into cash. The statement given matches this idea exactly: if you can’t pay liabilities in a timely manner, you’re facing liquidity risk because cash flow or the ability to convert assets to cash when needed is impaired.

This risk is different from market risk, which concerns how asset prices move due to market forces and may affect value but not necessarily the ability to pay bills on time. It’s also different from inflation risk, which is about loss of purchasing power over time rather than the immediacy of cash obligations. Regulatory risk relates to penalties, fines, or changes in rules that can influence cash flow, but the core issue of liquidity focuses on having enough cash now or quickly deployable assets to meet payables.