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Sheridan J. Titman, John D. Martin, Arthur J. Keown
Citation preview
9-1
Chapter 9Chapter 9
Cash and Marketable Cash and Marketable Securities Securities
ManagementManagement
Cash and Marketable Cash and Marketable Securities Securities
ManagementManagement© Pearson Education Limited 2004
Fundamentals of Financial Management, 12/eCreated by: Gregory A. Kuhlemeyer, Ph.D.
Carroll College, Waukesha, WI
9-2
After studying Chapter 9, After studying Chapter 9, you should be able to: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.
9-3
Cash and Marketable Cash and Marketable Securities ManagementSecurities Management
Motives for Holding Cash Speeding Up Cash Receipts S-l-o-w-i-n-g D-o-w-n
Cash Payouts Electronic Commerce
9-4
Cash and Marketable Cash and Marketable Securities ManagementSecurities Management
Outsourcing Cash Balances to Maintain Investment in Marketable
Securities
9-5
Motives for Holding CashMotives for Holding Cash
Transactions MotiveTransactions Motive -- to meet payments arising in the ordinary course of business
Speculative MotiveSpeculative Motive -- to take advantage of temporary opportunities
Precautionary MotivePrecautionary Motive -- to maintain a cushion or buffer to meet unexpected cash needs
9-6
Cash Management SystemCash Management System
Collections Disbursements
Marketable securitiesinvestment
Control through information reporting
= Funds Flow = Information Flow
9-7
Speeding Up Speeding Up Cash ReceiptsCash 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
9-8
Collection FloatCollection Float
Collection FloatCollection Float: total time between the mailingof the check by the customer and the availability
of cash to the receiving firm.
ProcessingProcessingFloatFloat
AvailabilityAvailabilityFloatFloat
MailMailFloatFloat
Deposit FloatDeposit Float
9-9
Mail FloatMail Float
Mail FloatMail Float: time the check is in the mail.
Customer Customer mails checkmails check
FirmFirmreceives checkreceives check
9-10
Processing FloatProcessing Float
Processing FloatProcessing Float: time it takes a companyto process the check internally.
FirmFirmdeposits checkdeposits check
FirmFirmreceives checkreceives check
9-11
Availability FloatAvailability Float
Availability FloatAvailability Float: time consumed in clearingthe check through the banking system.
FirmFirmdeposits checkdeposits check
Firm’s bankFirm’s bankaccount creditedaccount credited
9-12
Deposit FloatDeposit Float
Deposit FloatDeposit Float: time during which the check received by the firm remains uncollected funds.
Processing FloatProcessing Float Availability FloatAvailability Float
9-13
Earlier BillingEarlier Billing
Accelerate preparation and mailing of invoices
computerized billing
invoices included with shipment
invoices are faxed
advance payment requests
preauthorized debits
9-14
Preauthorized PaymentsPreauthorized Payments
Preauthorized debit 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.
9-15
Lockbox SystemsLockbox Systems
Traditional LockboxTraditional LockboxA post office box maintained by a firm’s bank that is used as a receiving point for customer
remittances.
Electronic LockboxElectronic 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.
9-16
Lockbox Process*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
9-17
Lockbox SystemLockbox System
DisadvantageDisadvantage
Cost of creating and maintaining a lockbox system. Generally, not
advantageous for small remittances.
AdvantageAdvantage
Receive remittances sooner which reduces processing float.
9-18
Concentration BankingConcentration Banking
Compensating BalanceCompensating Balance
Demand deposits maintained by a firm to compensate a bank for services
provided, credit lines, or loans.
Cash ConcentrationCash Concentration
The movement of cash from lockbox or field banks into the firm’s central cash pool residing in a concentration bank.
9-19
Concentration BankingConcentration 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 Moving cash balances to a central location:a central location:
9-20
Concentration Services Concentration Services for Transferring Fundsfor Transferring Funds
Definition: A non-negotiable check payable to a single company account at a concentration bank.
Funds are not immediately available Funds are not immediately available upon receipt of the DTC.upon receipt of the DTC.
(1) Depository Transfer Check (DTC)(1) Depository Transfer Check (DTC)
9-21
Concentration Services Concentration Services for Transferring Fundsfor Transferring Funds
Definition: An electronic version of the depository transfer check (DTC).
(1) Electronic check image version of Electronic check image version of the DTC.the DTC.
(2) Cost is not significant and is (2) Cost is not significant and is replacing DTC.replacing DTC.
(2) Automated Clearinghouse (2) Automated Clearinghouse (ACH) Electronic Transfer (ACH) Electronic Transfer
9-22
Concentration Services Concentration Services for Transferring Fundsfor 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 Funds are available upon receipt of the wire transfer. Much more expensive.wire transfer. Much more expensive.
(3) Wire Transfer(3) Wire Transfer
9-23
S-l-o-w-i-n-g D-o-w-n S-l-o-w-i-n-g D-o-w-n Cash PayoutsCash Payouts
“Playing the Float” Control of Disbursements
Payable through Draft (PTD) Payroll and Dividend
Disbursements Zero Balance Account (ZBA)
Remote and Controlled Disbursing
9-24
““Playing the Float”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 FloatNet 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.
9-25
Control of DisbursementsControl of Disbursements
Solution:Solution:
Centralize payables into a single (smaller number of) account(s). This provides better
control of the disbursement process.
Firms should be able to: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.
9-26
Methods of Managing Methods of Managing DisbursementsDisbursements
Delays the time to have funds on deposit Delays the time to have funds on deposit to cover the draft.to cover the draft.
Some suppliers prefer checks.Some suppliers prefer checks. Banks will impose a higher service charge Banks will impose a higher service charge
due to the additional handling involved. due to the additional handling involved.
Payable Through Draft (PTD):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.
9-27
Methods of Managing Methods of Managing DisbursementsDisbursements
Many times a separate account is set up to Many times a separate account is set up to handle each of these types of disbursements.handle each of these types of disbursements.
A distribution scheduled is projected based on A distribution scheduled is projected based on past experiences. [See slide 9-28]past experiences. [See slide 9-28]
Funds are deposited based on expected needs.Funds are deposited based on expected needs. Minimizes excessive cash balances.Minimizes excessive cash balances.
Payroll and Dividend DisbursementsPayroll and Dividend DisbursementsThe firm attempts to determine when payroll and dividend checks will be presented for collection.
9-28
Percentage of Payroll Percentage of Payroll Checks CollectedChecks Collected
F M T W H F M and after(Payday)(Payday)
Per
cen
t o
fP
erce
nt
of
Pay
roll
Co
llec
ted
Pay
roll
Co
llec
ted
100%
75%
50%
25%
0%
The firm may plan onpayroll checks beingpresented in a similar
pattern every pay period.
9-29
Methods of Managing Methods of Managing DisbursementsDisbursements
Eliminates the need to accurately Eliminates the need to accurately estimate each disbursement account.estimate each disbursement account.
Only need to forecast Only need to forecast overalloverall cash needs. cash needs.
Zero Balance Account (ZBA):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.
9-30
Remote and Remote and Controlled DisbursingControlled Disbursing
Example: Example: A Vermont business pays a Maine supplier with a check drawn on a bank in Montana.
This This maymay stress supplier relations, and raises ethical stress supplier relations, and raises ethical issues.issues.
Remote DisbursementRemote 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. This maximizes disbursement float.
9-31
Remote and Remote and Controlled DisbursingControlled Disbursing
Late check presentments are minimal, which Late check presentments are minimal, which allows more accurate predicting of allows more accurate predicting of
disbursements on a day-to-day basis.disbursements on a day-to-day basis.
Controlled DisbursementControlled 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.
9-32
Electronic CommerceElectronic Commerce
Messaging systems can be:1. UnstructuredUnstructured -- utilize technologies
such as faxes and e-mails faxes and e-mails
2. 2. StructuredStructured -- utilize technologies such such as as electronic data interchange (EDI)electronic data interchange (EDI)..
Electronic CommerceElectronic Commerce -- The exchange of business information in an electronic (non-paper) format, including over the Internet.
9-33
Electronic Data Electronic Data Interchange (EDI)Interchange (EDI)
Electronic Data InterchangeElectronic Data Interchange -- The movement of business data electronically
in a structured, computer-readable format.
EDIEDIElectronic Funds Transfer (EFT)Electronic Funds Transfer (EFT)
Financial EDI (FEDI)Financial EDI (FEDI)
9-34
Electronic Funds Electronic Funds Transfer (EFT)Transfer (EFT)
Electronic Funds Transfer (EFT)Electronic Funds Transfer (EFT) -- the electronic movements of information between two
depository institutions resulting in a value (money) transfer.
EDIEDISubsetSubset
Electronic Funds Transfer (EFT)Electronic Funds Transfer (EFT)
Society of Worldwide Interbank Financial Telecommunications (SWIFT)
Clearinghouse Interbank Payments System (CHIPS)
9-35
Electronic Funds Electronic Funds Transfer (EFT)Transfer (EFT)
New RegulationNew 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
9-36
Financial EDI (FEDI)Financial EDI (FEDI)
Financial EDIFinancial EDI -- The movement of financially related electronic information between a
company and its bank or between banks.
Financial EDI (FEDI)Financial EDI (FEDI)
Examples includeExamples include:
Lockbox remittance information
Bank balance information
EDIEDISubsetSubset
9-37
Costs and Benefits of EDICosts and Benefits of EDI
CostsCosts 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
BenefitsBenefits 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
9-38
OutsourcingOutsourcing
1. Improving company focus2. Reducing and controlling operating
costs 3. Freeing resources for other purposes
* The Outsourcing Institute, 2002
OutsourcingOutsourcing -- Subcontracting a certain business operation to an outside firm,
instead of doing it “in-house.”
Why might a firm outsourceWhy might a firm outsource?* ?*
9-39
Cash Balances to MaintainCash Balances to Maintain
The optimal level of cash should The optimal level of cash should be the larger of:be the larger of:
(1) the transaction balances required when cash management is efficient.
(2) the compensating balance requirements of commercial banks.
9-40
Investment in Investment in Marketable SecuritiesMarketable Securities
Marketable Securities are shown Marketable Securities are shown on the balance sheet as:on the balance sheet as:
1.1. Cash equivalents if maturities are Cash equivalents if maturities are less than three (3) months at the less than three (3) months at the time of acquisition.time of acquisition.
2.2. Short-term investments if remaining Short-term investments if remaining maturities are less than one (1) maturities are less than one (1) year.year.
9-41
The Marketable The Marketable Securities PortfolioSecurities Portfolio
Ready Cash Ready Cash Segment (R$)Segment (R$)
Optimal balance of Optimal balance of marketable securities marketable securities
held to take care of held to take care of probable deficiencies probable deficiencies
in the firm’s cash in the firm’s cash account.account.
R$F$
C$
9-42
Controllable Cash Controllable Cash Segment (C$)Segment (C$)
Marketable securities Marketable securities held for meeting held for meeting
controllable controllable (knowable) outflows, (knowable) outflows,
such as taxes and such as taxes and dividends.dividends.
The Marketable The Marketable Securities PortfolioSecurities Portfolio
R$F$
C$
9-43
Free Cash Free Cash Segment (F$)Segment (F$)
““Free” marketable Free” marketable securities (that is, securities (that is, available for as yet available for as yet
unassigned unassigned purposes).purposes).
The Marketable The Marketable Securities PortfolioSecurities Portfolio
R$F$
C$
9-44
Variables in Marketable Variables in Marketable Securities SelectionSecurities Selection
Marketability (or Liquidity)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.
SafetySafetyRefers to the likelihood of getting back the
same number of dollars you originally invested (principal).
9-45
Variables in Marketable Variables in Marketable Securities SelectionSecurities Selection
MaturityMaturity
Refers to the remaining life of the security.
Interest Rate (or Yield) RiskInterest Rate (or Yield) Risk
The variability in the market price of a security caused by changes in
interest rates.
9-46
Common Money Common Money Market InstrumentsMarket Instruments
Treasury Bills (T-bills)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 InstrumentsMoney Market InstrumentsAll government securities and short-term corporate obligations. (Broadly defined)
9-47
T-Bills and Bond Equivalent T-Bills and Bond Equivalent Yield (BEY) Method:Yield (BEY) Method:
BEYBEY = [ ( = [ (10001000 – – 990990) / () / (990990) ] *[ 365 / ) ] *[ 365 / 9191 ] ]
BEY = 4.05%BEY = 4.05%
BEYBEY = [ ( = [ (FAFA – – PPPP) / () / (PPPP) ] *[ 365 / ) ] *[ 365 / DMDM ] ]• 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?
9-48
T-Bills and Equivalent T-Bills and Equivalent Annual Yield (EAY) Method:Annual Yield (EAY) Method:
EAY = (1 + [EAY = (1 + [.0405.0405/(365 / /(365 / 91)91)])])365/365/9191 - 1 - 1
EAY = 4.11%EAY = 4.11%
EAY = (1 + [ EAY = (1 + [ BEY BEY / (365 / / (365 / DM)DM) ] ) ] )365/365/DMDM - 1 - 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 $990 described on the previous slide?
9-49
Common Money Common Money Market InstrumentsMarket Instruments
Treasury BondsTreasury Bonds: : Long-term (more than 10 years’ original maturity) obligations of the U.S. Treasury.
Treasury NotesTreasury Notes: : Medium-term (2-10 years’ original maturity) obligations of the U.S. Treasury.
9-50
Common Money Common Money Market InstrumentsMarket Instruments
Bankers’ Acceptances (BAs)Bankers’ Acceptances (BAs): : Short-term promissory trade notes for which a bank (by having “accepted” them) promises to pay the holder the face amount at maturity.
Repurchase Agreements (RPs; Repurchase Agreements (RPs; repos)repos): : Agreements to buy securities (usually Treasury bills) and resell them at a higher price at a later date.
9-51
Common Money Common Money Market InstrumentsMarket Instruments
Federal Agency SecuritiesFederal Agency Securities: : Debt securities issued by federal agencies and government-sponsored enterprises (GSEs). Examples: FFCB, FNMA, and FHLMC.
Commercial PaperCommercial Paper:: Short-term, unsecured promissory notes, generally issued by large corporations (unsecured IOUs). The largest dollar-volume instrument.
9-52
Common Money Common Money Market InstrumentsMarket Instruments
Negotiable Certificate of DepositNegotiable Certificate of Deposit: : A large-denomination investment in a negotiable time deposit at a commercial bank or savings institution paying a fixed or variable rate of interest for a specified period of time.
9-53
Common Money Common Money Market InstrumentsMarket Instruments
Money Market Preferred StockMoney Market Preferred Stock: : Preferred stock having a dividend rate that is reset at auction every 49 days.
EurodollarsEurodollars: : A U.S. dollar-denominated deposit -- generally in a bank located outside the United States -- not subject to U.S. banking regulations
9-54
Selecting Securities for Selecting Securities for the Portfolio Segmentsthe Portfolio Segments
Ready Cash Ready Cash Segment (R$)Segment (R$)
Safety and ability to Safety and ability to convert to cash is convert to cash is most important.most important.
Select Select U.S. U.S. TreasuriesTreasuries for this for this
segment.segment.
R$F$
C$
9-55
Controllable Cash Controllable Cash Segment (C$)Segment (C$)
Marketability less Marketability less important. Possibly important. Possibly match time needs.match time needs.
May select May select CDs, CDs, repos,repos, BAs,BAs, euroseuros for for
this segment.this segment.
R$F$
C$
Selecting Securities for Selecting Securities for the Portfolio Segmentsthe Portfolio Segments
9-56
Free Cash Free Cash Segment (F$)Segment (F$)
Base choice on yield Base choice on yield subject to risk-return subject to risk-return
trade-offs.trade-offs.
Any money market Any money market instrumentinstrument may be may be
selected for this selected for this segment.segment.
R$F$
C$
Selecting Securities for Selecting Securities for the Portfolio Segmentsthe Portfolio Segments