The challenge and skill refer to your skill, and the size of the challenge for you, as perceived by you. So for example, if you are presented with a task that is really easy for you, you could say it presents a low level of challenge. If you are really good at this particular task, then you may find it relaxing.
Say you are a good driver, and you need to get from your home to Norwich. You have nice car and it has a great sat nav system. The drive will present little challenge, and the weather is looking good. So on the challenge scale it will be low. Your skill level is high, so reading across the chart you’re likely to see the drive as a form of Relaxation.
You set off, and suddenly find that the sat nav is faulty. And you cannot navigate well at all. The challenge is now getting higher, and your skill level, at navigating, is low. Looking again the chart this is now reading Worry. If the weather was to turn sour as well, this may add even more to the challenge and now, high challenge and low skill, cue Anxiety.
At times, you may wish to aim to have a high challenge in those areas where you are highly skilled. Then you can achieve Flow. That lovely sense of where you really feel in the zone.
For a detailed description of flow, there is a lot of information on Wikipedia.
Image credit: w:User:Oliverbeatson [Public domain], via Wikimedia Commons