1. CHAPTER – TWO Management of Cash and Marketable Securities

2. Definition of Cash and Marketable Securities The term cash refers to all money items and sources that are immediately available to help pay a firm’s bills. On the balance sheet, cash assets include deposits in financial institutions and cash equivalents in money market funds or marketable securities. All highly liquid short-term securities are treated as cash. Three securities are widely used as short term investments and alternative forms of cash.

3. Continued Treasury Bill – is an unconditional promise by the govt. treasury to pay to the holder of the bill a specified amount at maturity. Treasury bills are issued for short periods of time, 3, 6 or 12 months. Two characteristics of treasury bills should be noted: Non-interest Bearing. Most secure and Liquid marketable Security

4. Continued Commercial and Finance Paper-Commercial Paper refers to short-term, unsecured promissory notes of large non-financial corporations. Finance paper refers to similar notes from finance companies. These notes are issued by firms needing cash for periods of 30 to 270 days. Negotiable Certificates of Deposits – is a receipt for a time deposit at bank or other financial institution. The bank agrees to pay the bearer the amount of the deposit plus a stipulated amount of interest at maturity.

5. Other Marketable Securities In addition to the three most popular securities for short term investment of excess cash, a other securities are available to the corporate treasurer. Some of these are: Treasury Notes and Bonds. Federal Agency issues. Money Market Funds. Banker’s Acceptances. Repurchase Agreements.

6. Management of Cash The term cash management refers to the management of cash from the time it starts its transit to the firm until it leaves the firm in payments. Cash management encompasses the design of collection and disbursement systems for cash and the temporary investment of cash while it resides with the firm. Cash Management: Objective Meeting payment schedule Minimizing funds committed to cash balances

7. Motives for Holding Cash Businesses have three primary motives for holding cash. These are: Transaction Motive – for holding cash is to enable the firm to conduct its ordinary business- making purchases and sales. Precautionary Motive- for holding cash relates primarily to the predictability of cash inflows and out flows. If the predictability is high, less cash need be held against an emergency or any other contingency.

8. Continued The other factor that strongly influences the precautionary motive is the ability to borrow additional cash on short notices. Speculative Motive- for holding cash is to enable the firm to accept profit making opportunities that may arise. Compensation Motive:

9. Factors Determining Cash Needs Synchronization of Cash Flows Short Costs Excess cash balance Costs Procurement and management Uncertainty and cash management

10. Managing the Collection and Disbursement of Cash Float: The difference between book cash and bank cash representing the net effect of cheeks in the process of clearing. Disbursement Float: Checks written by the firm generate disbursement float causing an immediate decrease in the book cash but no immediate change in bank cash. Collection Float: Checks received by the firm represents collection float which increase book cash immediately but does not immediately change bank cash.

11. Continued Net Float: The net effect that is the sum of the total collection and disbursement float. Float Management: Float management involves controlling the collection and disbursement of cash. The objective in cash collection is to speed up collection and reduce the lag between the consumers pay their bills and the time the cash become available. The objective in cash disbursement is to control payment and minimize the firm’s costs associated with making payments

12. Total collection and disbursement times can e broken into three parts: Mailing time Processing delay Availability delay

13. Accelerating Cash Collection Lock Boxes: Lock boxes is the most widely used device to speed up collection of cash. It is a special post office box set up to intercept accounts receivable payments. A lock box system reduces mailing time because checks are received at a near by post office instead of at corporate headquarters

14. continued Lock boxes also reduces firm’s processing time because they reduce the time required for a corporation to physically handling receivables and to deposit checks for collection. A bank lock box should enable a firm to get its receipts processed, deposited and cleared faster than if it were to receive checks at its head quarters and deliver them itself to the bank for deposit and clearing.

15. Concentration Banking With a concentration banking system the firm’s sale offices are usually responsible for the collection and processing of customers checks. The sale office deposit the checks into a local deposit bank account surplus funds are transferred from the deposit bank to the concentration bank.

16. Continued The purpose of concentration bank is to obtain customer checks from near by receiving locations. Concentration banking reduces mailing time because firm’s sale offices are usually nearer than corporate headquarter. Furthermore bank clearing time will be educed because the customer’s checks is usually drawn on a local bank.

17. Delaying disbursement Paying slowly is another technique of accelerating cash management. Technique to slow down disbursement will attempt to increase mailing time and check clearing time. Avoidance of early payments Centralized disbursement Float Accruals

18. Determining the Target Cash Balance The target cash balance involves a trade-off between the opportunity costs of holding too much cash and the trading costs of holding too little. If a firm tries to keep its cash holding too low, it will find itself selling marketable securities more frequently than if the cash balance cash balance was higher. Thus trading cost will tend to fall as the cash balance become larger. In contrast, the opportunity cost of holding cash rise as the cash holding rise.

19. The Baumol Model William Baumol was the first to provide a formal model of cash management incorporating opportunity costs and trading costs. His model can be used to establish the target cash balance. In this model the firm is assumed to receive cash periodically but to pay out cash continuously at a steady rate.

20. Continued The total cost associated with cash management, according to this model, has two elements: (1)Cost of converting marketable securities into cash- trading costs; (2) The lost opportunity cost. Equation----- Implication: 1) As the total cost needs for transaction rises because of expansion/ diversification etc., the optimal withdrawal increases less than proportionately.

21. This is the result of economy of scale in cash management. 2) As the opportunity interest rate (i) increases, the optimal cash withdrawal decreases. This is so because as (ii) increases, it is more costly to forfeit the investment opportunity and financial managers want to keep as much as cash in securities for as long as possible.

22. Limitations 1.The model assumes the firm has a constant disbursement rate. 2.The model assumes there no cash receipts during the projected period. 3.No safety stock is allowed for.

23. The Miller-Orr Model Metron Miller and Daniel orr developed a cash balance model to deal with cash inflows and outflows that fluctuate randomly from day to day. In the Miller-Orr model, both cash inflows and out flows are included. The model assumes that the distribution of daily net cash flows is normally distributed. On each day the net cash flow could be the expected value or some higher or lower value.

24. Marketable Securities Meaning and Characteristics: Ready marketability Safety of Principle Selection Criterion Financial Risk Interest Rate Risk Liquidity Taxability Yield among different financial assets