Cash Management (3)

Question 1

What does baumol model suggest?

Answer 1

There is a constant demand for cash

Question 2

What does the model suggest?

Answer 2

Regular transfers are made from interest-bearing, short-term investments (or bank deposit accounts) into a current account

Question 3

What does baumol model consider?

Answer 3

Annual demand for cash

Cost of each transfer from short-term investments into cash

Question 4

When does baumol model use EOQ?

Answer 4

To calculate the optimum amount of funds to transfer each time as short-term investments are converted into cash

Question 5

What does baumol model minimalise?

Answer 5

Opportunity cost of holding cash in the current account, thereby reducing the costs of cash management

Question 6

Assumptions of baumol model?

Answer 6

Cash requirements are funded by the sale of short-term investments

Constant annual demand for cash, interest rates, cost of each transfer

Question 7

Weaknesses of baumol model?

Answer 7

Assumption of constant demand for cash is unrealistic

Interest rates and transactions costs are not constant

Business must constantly use cash rather than generate

Question 8

Why is Miller-Orr > Baumol?

Answer 8

As it has a variable demand for cash

Question 9

Miller-Orr model cash balance?

Answer 9

it is allowed to vary between a lower limit set by management judgement and an upper limit calculated by the model

Question 10

If lower limit is reached in Miller-Orr?

Answer 10

An amount of cash equal to the difference between a default “return point” and the lower limit is raised by selling short-term investments

Question 11

If upper limit is reached in Miller-Orr?

Answer 11

An amount of cash equal to the difference between the upper limit and the return point is used to buy short-term investments

Question 12

What does Miller-Orr decrease?

Answer 12

Risk of running out of cash, while avoiding the loss of profit caused by having unnecessarily high cash balances

Question 13

What does Miller-Orr assume?

Answer 13

Cash requirements are funded by the sale of short-term investments

Fixed transaction cost per sale/purchase of short-term investments

Question 14

Weaknesses in Miller-Orr?

Answer 14

Subjectivity in setting lower limit

Buying/selling short-term investments are likely to be at least partly variable.

Complexity of estimating future volatility of cash flows