Which of the following best describes liquidity risk?

Liquidity risk is specifically defined as the risk of being unable to liquidate assets quickly at a fair price. This situation arises when market conditions or operational issues prevent an entity from executing transactions without significantly affecting the asset's price. Investors and firms may encounter liquidity risk when they need to sell an asset but find that there are insufficient buyers or that market demand has diminished, leading to potential losses on the sale.

In contrast, the other options describe different types of risks that are not directly related to liquidity. Interest rate risk pertains to the fluctuations in the value of assets or liabilities as interest rates change, which does not encapsulate the concept of liquidity. Inflated asset values refer to the situation where an asset is overvalued relative to its intrinsic value, which is a market risk rather than a liquidity risk. Finally, the risk associated with capital investments focuses on the potential loss from investing in projects rather than the ability to liquidate assets. Thus, the definition of liquidity risk aligns perfectly with the situation of not being able to liquidate assets when needed.