What is liquidity risk in bond investments?

Liquidity risk in bond investments primarily refers to the possibility that an investor may not be able to sell a bond quickly or without incurring a significant loss in value. This situation arises when there are not enough buyers in the market, leading to reduced demand and potentially forcing the seller to accept a lower price than anticipated.

Bonds, particularly those that are not frequently traded or are from smaller issuers, may exhibit high liquidity risk because they can be harder to sell quickly at a stable price. When market conditions are unfavorable or when specific bonds do not have a large trading volume, this risk increases. Therefore, the hallmark of liquidity risk is the concern that selling the bond may take time or negatively impact its market price.

The other options describe different types of risks associated with bonds. For instance, inflation affecting bond prices is related to market demand fluctuations but does not relate directly to liquidity. Interest rate fluctuations specifically address market conditions that influence bond values, rather than the ability to sell them promptly. Lastly, the risk of losing a bond due to issuer bankruptcy pertains to credit risk, where the issuer is unable to meet their debt obligations, rather than being focused on the liquidity of the asset itself.