What is the difference between credit risk and liquidity risk?

Question

What is the difference between credit risk and liquidity risk?

Answer 1

Liquidity risk refers to the chance that an entity will have insufficient cash flow to meet its obligations.  This can be caused by the undesirability of an asset in the marketplace, such as a company's products or fixed assets set for liquidation.

Credit risk is the risk of loss due to non-payment of debts owed by an entity.  Credit risk may be compounded by liquidity risk.

While you don't usually have the chance to pick between types of risk with a single entity, it is important to look at the factors that may increase the level of risk you face.  While a firm may presently be liquid, and able to meet its obligations, the wise investor looks forward to predict future market conditions that may adversely impact a firm's ability to meet its obligations.