Liquidity risk refers to?

Liquidity risk specifically refers to the potential difficulty an individual or entity may face in meeting short-term financial obligations due to an inability to convert assets into cash quickly without incurring significant losses. This concept is crucial for effective financial planning, as it highlights the importance of having readily available liquid assets to cover immediate expenses.

In practical terms, if someone has a significant amount of their wealth tied up in investments that cannot be easily or quickly converted to cash—such as real estate or certain stocks—they might find themselves unable to meet urgent financial needs or obligations, which could lead to defaults or other financial distress. Understanding liquidity risk helps individuals and organizations to ensure that they maintain sufficient cash reserves or easily accessible funds to handle unforeseen expenses or emergencies, contributing to financial stability.