Question

Q12. Consider the following statements about Liquidity Crisis:

1. This refers to a situation where an individual, a business or a government is unable to gather enough cash to meet its payment obligations to lenders.

2. A liquidity crisis is similar to a solvency crisis.

Which of the above statements are correct?

• A. a) 1 only
• B. b) 2 only
• C. c) Both 1 and 2
• D. d) Neither 1 nor 2

Answer 1

The correct option is A

a) 1 only

Liquidity Crisis

• This refers to a situation where an individual, a business or a government is unable to gather enough cash to meet its payment obligations to lenders.
• A liquidity crisis is different from a solvency crisis where the total value of an entity’s assets is less than the value of its overall liabilities.
• A business facing a liquidity crisis may be unable to meet its liabilities in a timely manner, but the value of its assets may still be much greater than that of its liabilities.
• In some cases, the inability to meet its immediate obligations can force a business to sell its assets at low prices to raise immediate cash. Such a fire sale of assets can end up threatening its solvency.