WCM Chapter-04.pptx - MODELS FOR THE MANAGEMENT OF CASH AND...

MODELS FOR THE MANAGEMENT
OF CASH AND TEMPORARY
INVESTMENT
By Kaniz Fatema
Lecturer, Finance, AIBA

Checking worthwhile of investment in short-term
The predominance of investment income over transaction
costs of investment does not hold if the amounts of funds are
small or the periods of investment are very short.
Example:
Invest for a month $100,000
Monthly interest rate .6% = $600
Transaction cost;
Investing- $50
Disinvesting- $50 = (-) $100
$500(Investment income)
If invest for 2 days;
Interest income(.02 per) = $40
Transaction costs = -$100
-$60 (Investment loss)

Checking worthwhile of investment in short-term
For maturity same amount can be loss or profit.
Any out-off pocket cost to make the investment can be
happened-
Transaction cost:

Stamp fee

Office fee

Information cost

Telephone fee

Communication cost

Commission postage

The opportunity cost of derivative managerial effort.

DETERMINATION OF THE OPTIMUM LEVEL OF CASH BALANCE
There are two approaches to derive an optimal cash
balance, namely,
a)
minimizing cost cash models and
b)
cash budget

In order to invest the excess funds, the financial manager
must know the minimum amount of cyclical requirement.

Also required to determine the optimal amount of cash
and bank balances, and in what quantity the securities
should be purchased or sold.

Certainty approach theory and uncertainty approach
theory.

Certainty Model- The Baumol Model
In this model the firm is assumed to receive cash
periodically but has to pay out cash continuously at a
steady rate.
The firm’s inflows are lumpy but its outflows are not. When
a firm receive cash, the firm puts enough cash in its
disbursement account to cover outflow until the next inflows
is received.
ASSUMPTIONS

Investment will yield a fixed rate of return per period
regardless of the length of investment

Transaction cost of investing and disinvesting is a fixed
cost, independent of the amount of investment.

Certainty Model- The Baumol Model
Appropriate strategy for investing the funds until they are
needed:

Two transaction strategy

Three transaction strategy
Two-transaction strategy :
According to the two-transaction strategy, when the cash
inflows is received, invest one-half of the total inflow, put
the remaining one-half in the disbursement account. During
the first half of the period, pay expenses from the
disbursement account.