determining optimum cash
TRANSCRIPT
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DETERMINING THE OPTIMUM
LEVELS OF CASH BALANCE
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IN ORDER TO INVEST EXCESSFUNDS,THEFINANCIAL MANAGER MUST KNOW
MINIMUM AMOUNT THAT MUST BE KEPT IN FORM
OF THE CASH .SEASONAL FACTORS AND CYCLICAL
REQUIRENENTS MAKE IT DIFFICULT TO ASCERTAIN
THESE AMOUNT ACCURATELY.A RANGE OF CASHMANAGEMENT MODELS WHICH MAY BE USED BY
THE FINANCE MANAGER HELP HIM TO MAINTAIN
APPROX. ENOUGH CASH IN THE CO. TO COVER
TRANSACTIONS PRECAUTIONARY ANDSPECULATIVE BALANCE . THESE MODELS ARE
DISCUSSED BELOW.
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BAUMOL MODEL
IN THIS MODEL FIRM IS ASSUMSD TORECEIVE CASH PERIODICALLY BUT TOPAY OUT CASH CONTINUOUSLY AT THE
STEADY RATE.I.E THE FIRMS INFLOWSARE LUMPY BUT ITS OUTFLOWS ARE
NOT.WHEN THE CASH INFLOWS IS
RECEIVED THE FIRM PUTS ENOUGH
CASHINITS DISBURSEMENT A/C TOCOVER OUTFLOWS UNTIL THE NEXT
INFLOW IS RECEIVED.
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THERE ARE SEVERAL TYPES OF BUSINESS
THAT EXPERIENCETIME PATTERN OF CASHFLOW SIMILAR TO THIS.FOR EXAMPLE
FOR FIRM THAT MANAGE RENTAL PROPERTY
RENTS ARE OFTEN RECEIVED OVER ASHORTPERIOD EARLY IN THE MONTH BUT OTHER
EXPENSES CONTINUE EVENLY THROUGH OUT
THE MONTH
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ASSUMPTIONS OF THIS MODEL
ARE;
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IT ASSUMES THAT INVESTMENT YIELD
AFIXED RATE OF RETURN PER PERIOD
REGARDLESS OF THE LENGTH OF THEINVESTMENT
THE TRANSACTION COST OF INVESTING AND
DIS INVESTINGIS A FIXED COST I.E INDEPENDENT OF THE
INVESTMENT THESE TRANSACTION COST
CONSIST
OF ALL THE OUT OF POCKET COST OF
MAKING OR SELLING THE INVESTMENT
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COMMISSIONS, POSTAGE TELEPHONE
CHARGES,OPPORTUNITY COST OFDIVERTED MANAGERIAL EFFORTS AND
SO FORTH
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STRATEGIES
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1. TWO TRANSACTION
STRATEGY
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WHEN THE CASH INFLOW IS RECEIVED
INVEST ONE HALF OF THE TOTAL INFLOW PUT
THE REMAINING ONE HALF IN DISBURSEMENT
A/C.
DURING THE FIRST HALF OF THE PERIOD PAY
DISBURSEMENT FROM THE DISBURSEMENT
A/C .THIS A/CWILL BE DRAINED ONE HALF OF THE WAY
THROUGH THE PERIOD. AT THAT TIME SELL
THE INV. AND PLACE THE RESULTING FUNDS
IN THE DISBURSEMENT A/C.
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USE THESE FUNDS TO PAY
DISBURSEMENTS DURING THE
REMAINDER OF THE PERIOD
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TO SEE THE NET GAIN FROM THIS
STRATEGY LET Y BE THE AMOUNT OF
THE CASH INFLOW AND i BE THEINTEREST RATE PER PERIOD.SINCE IN
THIS STRATEGY ONE HALF THE INFLOW
IS INVESTED FOR ONE HALF THE
PERIOD,THE INTEREST INCOME IS
INVESTMENT INCOME=(1/2)(1/2)iy=(1/4)iy
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BUT THERE ARE TWO TRANSACTION IN THIS
SRTATEGY: ONE INVESTMENT AND ONEDISINVESTMENT.IF THE COST PER
TRANSACTION IS a,THE TRANSACTION COST
OF THIS STRATEGY IS 2l,AND THE PROFIT IS
PROFIT=(1/4)iy 2a
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2).THREE TRANSACTION
STRATEGY
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1). WHEN THE CASH FLOW IS RECEIVED,
INITIALLY INVEST TWO-THIRD OF IT.PLACE
THE REMAINING ONE THIRD IN THEDISBURSEMENT A/C.
2). ONE THIRD OF THE WAY THROUGH THE
PERIOD, THE DISBURSEMENT A/C WILL BEEXHAUSTED.AT THE TIME, DISINVEST ONE
HALF OF THE FUNDS IN THE INV. A/C.
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THIS STRATEGY INVOLVES ONE INV.
TRANSACTION AND TWO DISINVESTMENTTRANSACTION.THIS STRATEGY CAPTURE A
GREATER
PORTION OF THE INITIAL CASH INFLOW IN
THE INV. A/C
INTERESTINCOME=(2/3)(1/3)iy+(1/3)(1/3)iy=(1/3)iy
AND PROFIT= (1/3)iy 3a
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3). OPTIMAL STRATEGY
THIS STRATEGY IS BASED UPON THE
OPTIMAL NO. OF TRANSACTIONS FORA FIRM WITH PERIODIC INFLOW AND
STEADY OUTFLOWS. IN GENERAL THE
INTEREST INCOME FROM INV.
STRATEGIES IN THIS SITUATIONIS:
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INTEREST INCOME=[n-1/2n]
where n= no. of transaction
profit =[(n-1)/ 2n] iy - na
as the no. of transaction inc., the int. income
inc. but so does the total transaction costs .
For some level of n,the profit is at a max.
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To find this we take first derivative of the
profit function,and solve for the optimal n.
n*=(iy/2a)1/2
where n* = optimal no. of transaction
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For ex.: a firm runs an apartment complex cash
comes in the beginning of the month and is
disbursed uniformly through out the followingmonths. For the up coming month,
the firm expects to have cash expenses of
rs.2,50,000. by investing in a money mkt. a/c. it can
earn 0.5 % per month. Transaction cost areestimated at rs. 50 per transaction .what is the firm
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To formulate this strategy, the optimal no. of
transactions is first computed:
n*=(iy /2a)1/2
= [(0.005) (2,50,000)/2(50)]1/2
= 5.o
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Profit=[(n-1)/2n] iy na
=(5-1)/2(5)(0.005)(2,50,000)-5(50)
= 500 250 = rs. 250
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THE BERANEK MODEL