Summary• Purpose of efficient cash management. • Methods for speeding up the collection of accounts

receivable and methods for controlling cash disbursements. • Remote and controlled disbursement, • How electronic data interchange (EDI) and

outsourcing each relates to a company’s cash collections and disbursements.

Chapter 9 (II)

Cash and Marketable Securities Management

Learning OutcomesAfter studying Chapter 9, you should be able to:• List and explain the motives for holding cash.• Understand the purpose of efficient cash management. • Describe methods for speeding up the collection of accounts

receivable and methods for controlling cash disbursements. • Differentiate between remote and controlled disbursement, • Discuss how electronic data interchange (EDI) and outsourcing

each relates to a company’s cash collections and disbursements.• Identify the key variables that should be considered before

purchasing any marketable securities. • Define the most common money-market instruments that a

marketable securities portfolio manager would consider for investment.

• Describe the three segments of the marketable securities portfolio and note which securities are most appropriate for each segment and why.

Outsourcing

• Outsourcing -- Subcontracting a certain business operation to an outside firm, instead of doing it in-house.

• Advantages1. Improves company efficiency2. Quality improvement through specialization3. Reducing and controlling operating costs 4. Freeing resources for other purposes

Cash Balances to Maintain

The optimal level of cash should include:

(1) the transaction balances required when cash management is efficient.

(2) the compensating balance requirements of commercial banks.

Investment in Marketable Securities

Having cash available in the accounts for longer periods of time requires efficient investment decisions in the marketable securities.

Marketable Securities are shown on the balance sheet as:1. Cash equivalents if maturities are less than three

3 months at the time of acquisition.2. Short-term investments if remaining maturities

are less than one 1 year.

The Marketable Securities Portfolio

Ready Cash Segment (R$)Optimal balance of marketable securities held to take care of probable deficiencies in the firm’s cash account.

R$F$

C$

Controllable Cash Segment (C$)

Marketable securities held for meeting controllable (knowable) outflows, such as taxes and dividends.

The Marketable Securities Portfolio

R$F$

C$

Free Cash Segment (F$)

“Free” marketable securities (that is, available for as yet unassigned purposes).

The Marketable Securities Portfolio

R$F$

C$

Variables in Marketable Securities Selection

Marketability (or Liquidity)The ability to sell a significant volume of securities in a short period of time in the secondary market without significant price concession.

SafetyRefers to the likelihood of getting back the same number of dollars you originally invested, i.e. recovery of principal invested.

Variables in Marketable Securities Selection

MaturityRefers to the remaining life of the security.

Interest Rate (or Yield) RiskThe variability in the market price of a security caused by changes in interest rates.

Common Money Market Instruments

Treasury Bills (T-bills): Short-term, non-interest bearing obligations of the U.S. Treasury issued at a discount and redeemed at maturity for full face value. Minimum $1,000 amount and $1,000 increments thereafter.

Money Market InstrumentsAll government securities and short-term corporate obligations.

T-Bills and Bond Equivalent Yield (BEY) Method:

BEY = [ (FA – PP) / (PP) ] *[ 365 / DM ]FA: face amount of securityPP: purchase price of securityDM: days to maturity of security

A $1,000, 26-week T-bill is purchased for $956 – what is its BEY?

BEY = [ (1000 – 956) / (956) ] *[ 365 / 182 ]BEY = 9.23%

T-Bills and Equivalent Annual Yield (EAY) Method:

EAY = (1 + [ BEY / (365 / DM) ] )365/DM - 1BEY: bond equivalent yield from the previous slideDM: days to maturity of security

Calculate the EAY of the $1,000, 26-week T-bill purchased for $956 described on the previous slide?

EAY = (1 + [.0923/(365 / 182)])365/182 - 1EAY = 9.44%

Common Money Market Instruments

Treasury Bonds: Long-term obligations of the U.S. Treasury having more than 10 years’ original maturity.

Treasury Notes: Medium-term obligations of the U.S. Treasury with a 2-10 years’ original maturity.

Common Money Market Instruments

Bankers’ Acceptances (BAs): Short-term promissory trade notes for which a bank promises to pay the holder the face amount at maturity. These notes are sold at a discount are repurchased at face value.

Repurchase Agreements (RPs; repos): Agreements to buy securities (usually Treasury bills) and resell them at a higher price at a later date, the increment in price is linked to the days to maturity.

Common Money Market Instruments

Federal Agency Securities: Debt securities issued by federal agencies and government-sponsored enterprises (GSEs).

Commercial Paper: Short-term, unsecured promissory notes generally issued by large corporations. The largest dollar-volume instrument.

Common Money Market Instruments

Negotiable Certificate of Deposit: A large-denomination investment in a negotiable time deposit at a commercial bank or savings institution paying a fixed or variable rate of interest for a specified period of time.

Selecting Securities for the Portfolio Segments

Ready Cash Segment (R$)Safety and ability to convert to cash is most important.Select Government Treasuries for this segment.

R$F$

C$

Controllable Cash Segment (C$)

Marketability less important. Possibly match time needs.May select repos, Bankers Acceptance notes, for this segment.

Selecting Securities for the Portfolio Segments

R$F$

C$

Free Cash Segment (F$)

Base choice on yield subject to risk-return trade-offs.Any money market instrument may be selected for this segment.

Selecting Securities for the Portfolio Segments

R$F$

C$

Problem 1

Problem 2

Problem 3

Problem 4

Summary• Key variables that should be considered before

purchasing any marketable securities. • Common money-market instruments that a

marketable securities portfolio manager would consider for investment. • Three segments of the marketable securities portfolio

and which securities are most appropriate for each segment and why.