1 Chapter 9 Cash and Marketable Securities Management Muhammad Afzal, NTI
Nov 17, 2014
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Chapter 9
Cash and Marketable Securities
Management
Cash and Marketable Securities
Management
Muhammad Afzal, NTI
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After 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, and discuss
any ethical concerns raised by either of these two methods. 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.
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Cash and Marketable Securities Management
Motives for Holding Cash Speeding Up Cash Receipts S-l-o-w-i-n-g D-o-w-n
Cash Payouts Electronic Commerce
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Cash and Marketable Securities Management
Outsourcing Cash Balances to Maintain Investment in Marketable
Securities
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Motives for Holding Cash
Transactions Motive -- to meet payments arising in the ordinary course of business
Speculative Motive -- to take advantage of temporary opportunities
Precautionary Motive -- to maintain a cushion or buffer to meet unexpected cash needs
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Cash Management System
Collections Disbursements
Marketable securitiesinvestment
Control through information reporting
= Funds Flow = Information Flow
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Speeding Up Cash Receipts
Expedite preparing and mailing the invoice
Accelerate the mailing of payments from customers
Reduce the time during which payments received by the firm remain uncollected
Collections
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Collection Float
Collection Float: total time between the mailingof the check by the customer and the availability
of cash to the receiving firm.
ProcessingFloat
AvailabilityFloat
MailFloat
Deposit Float
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Mail Float
Mail Float: time the check is in the mail.
Customer mails check
Firmreceives check
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Processing Float
Processing Float: time it takes a companyto process the check internally.
Firmdeposits check
Firmreceives check
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Availability Float
Availability Float: time consumed in clearingthe check through the banking system.
Firmdeposits check
Firm’s bankaccount credited
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Deposit Float
Deposit Float: time during which the check received by the firm remains uncollected funds.
Processing Float Availability Float
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Earlier Billing
Accelerate preparation and mailing of invoices
computerized billing invoices included with shipment invoices are faxed advance payment requests preauthorized debits
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Preauthorized Payments
Preauthorized debit
The transfer of funds from a payor’s bank account on a specified date to
the payee’s bank account; the transfer is initiated by the payee
with the payor’s advance authorization.
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Lockbox Systems
Traditional LockboxA post office box maintained by a firm’s bank that is used as a receiving point for customer
remittances.
Electronic LockboxA collection service provided by a firm’s bank
that receives electronic payments and accompanying remittance data and
communicates this information to the company in a specified format.
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Lockbox Process*
Customers are instructed to mail their remittances to the lockbox location.
Bank picks up remittances several times daily from the lockbox.
Bank deposits remittances in the customers account and provides a deposit slip with a list of payments.
Company receives the list and any additional mailed items.
* Based on the traditional lockbox system
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Lockbox System
Disadvantage
Cost of creating and maintaining a lockbox system. Generally, not
advantageous for small remittances.
Advantage
Receive remittances sooner which reduces processing float.
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Concentration Banking
Compensating BalanceDemand deposits maintained by a firm
to compensate a bank for services provided, credit lines, or loans.
Cash Concentration
The movement of cash from lockbox or field banks into the firm’s central cash pool residing in a concentration bank.
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Concentration Banking
Improves control over inflows and outflows of corporate cash.
Reduces idle cash balances to a minimum.
Allows for more effective investments by pooling excess cash balances.
Moving cash balances to a central location:
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Concentration Services for Transferring Funds
Definition: A non-negotiable check payable to a single company account at a concentration bank.
Funds are not immediately available upon receipt of the DTC.
(1) Depository Transfer Check (DTC)
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Concentration Services for Transferring Funds
Definition: An electronic version of the depository transfer check (DTC).
(1) Electronic check image version of the DTC.
(2) Cost is not significant and is replacing DTC.
(2) Automated Clearinghouse (ACH) Electronic Transfer
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Concentration Services for Transferring Funds
Definition: A generic term for electronic funds transfer using a two-way communications system, like Fedwire.
Funds are available upon receipt of the wire transfer. Much more expensive.
(3) Wire Transfer
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S-l-o-w-i-n-g D-o-w-n Cash Payouts
“Playing the Float” Control of Disbursements
Payable through Draft (PTD) Payroll and Dividend
Disbursements Zero Balance Account (ZBA)
Remote and Controlled Disbursing
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“Playing the Float”
You write a check today, which is subtracted from your calculation of the account balance.
The check has not cleared, which creates float. You can potentially earn interest on money that
you have “spent.”
Net Float -- The dollar difference between the balance shown in a firm’s (or
individual’s) checkbook balance and the balance on the bank’s books.
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Control of Disbursements
Solution:
Centralize payables into a single (smaller number of) account(s). This provides better
control of the disbursement process.
Firms should be able to:
1. shift funds quickly to banks from which disbursements are made.
2. generate daily detailed information on balances, receipts, and disbursements.
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Methods of Managing Disbursements
Delays the time to have funds on deposit to cover the draft.
Some suppliers prefer checks. Banks will impose a higher service charge
due to the additional handling involved.
Payable Through Draft (PTD):A check-like instrument that is drawn against the payor and not against a bank as is a check. After
a PTD is presented to a bank, the payor gets to decide whether to honor or refuse payment.
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Methods of Managing Disbursements
Many times a separate account is set up to handle each of these types of disbursements.
A distribution scheduled is projected based on past experiences. [See slide 9-28]
Funds are deposited based on expected needs. Minimizes excessive cash balances.
Payroll and Dividend DisbursementsThe firm attempts to determine when payroll and dividend checks will be presented for collection.
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Percentage of Payroll Checks Collected
F M T W H F M and after(Payday)
Per
cen
t o
fP
ayro
ll C
oll
ecte
d
100%
75%
50%
25%
0%
The firm may plan onpayroll checks beingpresented in a similar
pattern every pay period.
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Methods of Managing Disbursements
Eliminates the need to accurately estimate each disbursement account.
Only need to forecast overall cash needs.
Zero Balance Account (ZBA):A corporate checking account in which a zero balance is maintained. The account requires a master (parent) account from which funds are drawn to cover negative balances or to which
excess balances are sent.
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Remote and Controlled Disbursing
Example: A Vermont business pays a Maine supplier with a check drawn on a bank in Montana.
This may stress supplier relations, and raises ethical issues.
Remote Disbursement -- A system in which the firm directs checks to be drawn on a bank
that is geographically remote from its customer so as to maximize check-clearing time.
This maximizes disbursement float.
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Remote and Controlled Disbursing
Late check presentments are minimal, which allows more accurate predicting of
disbursements on a day-to-day basis.
Controlled Disbursement -- A system in which the firm directs checks to be drawn on a bank (or branch bank) that is able to give early or mid-morning notification of the total dollar amount of checks that will
be presented against its account that day.
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Electronic Commerce
Messaging systems can be:1. Unstructured -- utilize technologies
such as faxes and e-mails 2. Structured -- utilize technologies such
as electronic data interchange (EDI).
Electronic Commerce -- The exchange of business information in an electronic (non-paper) format, including over the Internet.
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Electronic Data Interchange (EDI)
Electronic Data Interchange -- The movement of business data electronically
in a structured, computer-readable format.
EDIElectronic Funds Transfer (EFT)
Financial EDI (FEDI)
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Electronic Funds Transfer (EFT)
Electronic Funds Transfer (EFT) -- the electronic movements of information between two
depository institutions resulting in a value (money) transfer.
EDISubset
Electronic Funds Transfer (EFT)
Society of Worldwide Interbank Financial Telecommunications (SWIFT)
Clearinghouse Interbank Payments System (CHIPS)
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Electronic Funds Transfer (EFT)
New Regulation
In January 1999, a new regulation requires ALL federal government payments be made electronically.* This will:
• provide more security than paper checks and• be cheaper to process for the government.
* Except tax refunds and special waiver situations
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Financial EDI (FEDI)
Financial EDI -- The movement of financially related electronic information between a
company and its bank or between banks.
Financial EDI (FEDI)
Examples include:
Lockbox remittance information
Bank balance information
EDISubset
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Costs and Benefits of EDI
Costs Computer hardware and
software expenditures Increased training costs
to implement and utilize an EDI system
Additional expenses to convince suppliers and customers to use the electronic system
Loss of float
Benefits Information and payments
move faster and with greater reliability
Improved cash forecasting and cash management
Customers receive faster and more reliable service
Reduction in mail, paper, and document storage costs
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Outsourcing
1. Improving company focus2. Reducing and controlling operating
costs 3. Freeing resources for other purposes
* The Outsourcing Institute, 2002
Outsourcing -- Subcontracting a certain business operation to an outside firm,
instead of doing it “in-house.”
Why might a firm outsource?*
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Cash Balances to Maintain
The optimal level of cash should be the larger of:
(1) the transaction balances required when cash management is efficient.
(2) the compensating balance requirements of commercial banks.
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Investment in 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.
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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$
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Controllable Cash Segment (C$)
Marketable securities held for meeting
controllable (knowable) outflows,
such as taxes and dividends.
The Marketable Securities Portfolio
R$F$
C$
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Free Cash Segment (F$)
“Free” marketable securities (that is, available for as yet
unassigned purposes).
The Marketable Securities Portfolio
R$F$
C$
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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 (principal).
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Variables in Marketable Securities Selection
Maturity
Refers to the remaining life of the security.
Interest Rate (or Yield) Risk
The variability in the market price of a security caused by changes in
interest rates.
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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. (Broadly defined)
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T-Bills and Bond Equivalent Yield (BEY) Method:
BEY = [ (1000 – 990) / (990) ] *[ 365 / 91 ]
BEY = 4.05%
BEY = [ (FA – PP) / (PP) ] *[ 365 / DM ]• FA: face amount of security• PP: purchase price of security• DM: days to maturity of security
A $1,000, 13-week T-bill is purchased for $990 – what is its BEY?
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T-Bills and Equivalent Annual Yield (EAY) Method:
EAY = (1 + [.0405/(365 / 91)])365/91 - 1
EAY = 4.11%
EAY = (1 + [ BEY / (365 / DM) ] )365/DM - 1• BEY: bond equivalent yield from the previous slide• DM: days to maturity of security
Calculate the EAY of the $1,000, 13-week T-bill purchased for $990 described on the previous slide?
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Common Money Market Instruments
Treasury Bonds: Long-term (more than 10 years’ original maturity) obligations of the U.S. Treasury.
Treasury Notes: Medium-term (2-10 years’ original maturity) obligations of the U.S. Treasury.
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Common Money Market Instruments
Bankers’ Acceptances (BAs): Short-term promissory trade notes for which a bank (by having “accepted” them) promises to pay the holder the face amount at maturity.
Repurchase Agreements (RPs; repos): Agreements to buy securities (usually Treasury bills) and resell them at a higher price at a later date.
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Common Money Market Instruments
Federal Agency Securities: Debt securities issued by federal agencies and government-sponsored enterprises (GSEs). Examples: FFCB, FNMA, and FHLMC.
Commercial Paper: Short-term, unsecured promissory notes, generally issued by large corporations (unsecured IOUs). The largest dollar-volume instrument.
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Common Money Market Instruments
Negotiable Certificate of Deposit: A large-denomination investment in a negotiable time deposit at a commercial bank or savings institution paying a fixed or variable rate of interest for a specified period of time.
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Common Money Market Instruments
Money Market Preferred Stock: Preferred stock having a dividend rate that is reset at auction every 49 days.
Eurodollars: A U.S. dollar-denominated deposit -- generally in a bank located outside the United States -- not subject to U.S. banking regulations
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Selecting Securities for the Portfolio Segments
Ready Cash Segment (R$)
Safety and ability to convert to cash is most important.
Select U.S. Treasuries for this
segment.
R$F$
C$
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Controllable Cash Segment (C$)
Marketability less important. Possibly match time needs.
May select CDs, repos, BAs, euros for
this segment.
R$F$
C$
Selecting Securities for the Portfolio Segments
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Free Cash Segment (F$)
Base choice on yield subject to risk-return
trade-offs.
Any money market instrument may be
selected for this segment.
R$F$
C$
Selecting Securities for the Portfolio Segments