Chapter 17 Cash and Marketable Securities Market

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Chapter 17Cash and Marketable Securities Market
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• Cash
• is the currency and coin the firm has on hand in
  petty cash drawers, in cash registers, or in
  checking accounts at the various commercial banks
  where its demand deposits are maintained.
• Marketable Securities
• those security investments the firm can quickly
  convert into cash balances
• Near Cash, Near-Cash Asset, Liquid Assets
• asset that can be converted to cash in a short
  period of time.

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Objective 1 Why A Company Holds Cash

• Cash Flow Process
• 1. Cash Inflow
• Irregular - not daily or frequent
• Bond sales, other debt contracts, P/S sale, C/S
  sale
• sale of marketable securities
• Regular
• collections from A/R, cash sale, sale of
  inventory and fixed asset

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• 2. Cash Outflows
• Irregular
• Payment of dividends, interest, principal on
  debt, Share repurchase, Taxes payment
• purchase of marketable securities
• Regular
• investment in fixed asset (capital expenditure
  program)
• investment in inventory

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• Figure 17-1 Cash Generation and Disposition
  Process
• Irregular Cash Inflows
• Bond sales
• Irregular Outflows other debt contracts
• Dividends Preferred Stock sales
• Interest Common Stock sales
• Principal on debt Out
  Purchase
• Share repurchase lt---------- CASH BALANCE
  ----------------------gt Marketable
• Taxes lt--------------------
  Securities
• --------------------------------------
  Sale
• ------------------ Purchase
  Labor and Material
• v
  v
• Fixed assets ----------------------gt
  Inventory -------------gt Receivables
• 
  
  
• --------------------------------v-----------------
  -------------------v------------------------------
  -v
• Sale Cash Sales Collections

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Motives for Holding Cash

• 1. Transaction Motive
• arise in the ordinary course of doing business.
• 2. Precautionary Motive
• to satisfy possible, but as yet indefinite,
  needs.
• affected by the cash flow predictability, and
  access to external fund
• the motive is met by holding a portfolio of
  liquid assets
• 3. Speculative Motive
• to take advantage of potential profit making
  situations

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Objective 2 Cash-Management Objectives and
Decisions

• The Risk-Return Tradeoff
• Insolvency when the firm is unable to meet its
  maturing liabilities on time
• Technically Insolvent lack of necessary
  liquidity to make prompt payment on its current
  debt obligations
• To avoid the insolvency is to keep large amount
  of cash
• However, the explicit return on cash is zero

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• A large cash investment
• minimizes the chances of insolvency,
• but penalizes company profitability
• A small cash investment
• frees excess balances for investment in both
  marketable securities and long-lived assets,
  which will enhance profit
• increases the chances of running out of cash -
  insolvency

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The Objectives

• The risk-return tradeoff can be reduced to two
  prime objectives for cash-management system
• 1. Enough cash must be on hand to meet the
  disbursal needs that arise in the course of doing
  business
• 2. Investment in idle cash balances must be
  reduced to a minimum.

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The Decisions

• Two conditions would allow cash balance near or
  at a level of zero
• 1. A completely accurate forecast of net cash
  flows over the planning horizon
• 2. Perfect synchronization of cash receipts and
  disbursements.
• These ideals are not met in practice
• to forecast cash flow can be done by preparing
  the Cash Budget

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• Answer the following questions
• 1. What can be done to speed up cash collections
  and slow down or better control cash outflows?
• 2. What should be the composition of a
  marketable securities portfolio?
• 3. How should investment in liquid assets be
  split between actual cash holdings and marketable
  securities?

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Objective 6 (page 669)Marketable Security
Alternatives

• 1. Treasury Bills
• the best known and the most popular
• a direct obligation of the government , normally
  90 days
• sold on a discount basis, investors do not
  receive interest, the return is the difference
  between the purchase price and face value
• there is a very active secondary market for
  T-bill, extremely liquid
• With no financial risk and high degree of
  liquidity,
• the yields are lower

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• 2. Federal Agency Securities
• debt obligations of corporations and agencies
  that have been created to effect the various
  lending programs of the government.
  (government-sponsored corporations)
• The Federal National Mortgage Association(FNMA),
  The Federal Home Loan Banks, the Federal Land
  Banks, the Banks for Cooperatives.
• not issued by government, so there is financial
  risk, and with less marketability, the yield is
  higher than T-Bill

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• 3. Bankers Acceptance
• An acceptance is a draft (order to pay)
• drawn on a specific bank by an exporter
• in order to obtain payment for goods shipped to a
  customer,who maintains an account with that
  specific bank.
• sold on a discount basis,and are payable to the
  holder of the paper
• A secondary market for the acceptance of large
  banks does exist.
• greater financial risk and less liquidity, yield
  will be higher.

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• Process of Creation of Bankers Acceptance
• U.S.importer wants to import from Tokyo. He goes
  to U.S bank, which examine his credit standing.
• U.S bank sends the Tokyo exporter a letter of
  credit which authorizes the Tokyo exporter to
  draw a draft on U.S.bank.
• U.S. importer signs a contract with his bank
  agreeing to pay the bank equal to the draft
  amount plus a commission
• Tokyo exporter receives letter of credit, then
  draws a time draft on U.S. bank and releases the
  product for shipment. He retains possession of
  critical documents associates with the sale (bill
  of lading, the transfer of title to the
  merchandise,the insurance paper)

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• Process (cont.)
• Tokyo exporter will not want to wait several
  months, so he will obtain cash at once by selling
  the draft with Tokyo bank at less than face
  value. The shipping documents are turned over to
  Tokyo bank.
• Tokyo bank will forward the draft and shipping
  documents to its correspondent bank in U.S. The
  correspondent bank will present the draft to the
  U.S.bank for acceptance.
• U.S. bank will observe that the drafts was
  authorized by its own letter of credit, will
  detach all shipping documents, and stamp the
  draft Acceptance. At this time, the bankers
  acceptance is created. It is now a negotiable
  instrument, payable to the bearer.

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• Process (cont.)
• The maturity period of acceptance will be
  prearranged between the U.S. importer and its
  bank. Maturity period starts when draft is
  presented for acceptance. Most drafts are Sight
  Drafts, i.e. if 90 days, the ninety-day period
  begins after the U.S. bank accepts the draft.
• After accepting the draft, U.S.bank will notify
  the U.S.importer that he can pick up the shipping
  documents, which will enable him to take
  possession of product.
• In exchange for the document, U.S.bank will
  obtain a signed document from importer as a
  security (i.e. sign a contract)

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• Process (cont.)
• the correspondent (with Tokyo) bank which now
  holds the acceptance. Tokyo bank will instruct
  either
• hold the acceptance until maturity as an
  investment and get money from U.S.bank
• immediately sell the acceptance in the market and
  credit its deposit account.

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• 4. Negotiable Certificates of Deposit (CD)
• a marketable receipt for funds that have been
  deposited in a bank for a fixed time period.
• Corporate CD- not those offered to individuals.
• when CD matures, the owner receives the full
  amount deposited plus the earned interest.

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• 5. Commercial Paper
• short-term, unsecured promissory notes sold by
  large businesses to raise cash
• they are unsecured, use only good credit ratings.
• normally 270 days
• generally sold on discount basis
• normally investors will hold it until maturity,
  so there is no active trading in a secondary
  market

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• 6. Repurchase Agreements
• Legal contracts that involve the actual sale of
  securities by a borrower to the lender, with a
  commitment on the part of the borrower to
  repurchase the securities at the contract price
  plus a stated interest charge.
• the securities sold to the lender are government
  issue or other money market instruments.
• the borrowers are financial institution,
  commercial banks, or a dealer.

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• 6. Repurchase Agreements (cont.)
• why buy the repurchase agreement, not other
  marketable security?
• maturity can be adjusted to suit needs
• the contract price is fixed, is protected against
  market price fluctuation throughout the contract
  period.

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• 7. Money Market Mutual Funds or Liquid-Asset
  Funds
• The Money Market Funds company sells their shares
  to the public
• The Fund manager typically invests money in a
  diversified portfolio of short-term high-grade
  debt instruments. Some invest in more risky
  instruments.
• The Money Market Funds sell their shares to raise
  cash, and by pooling the funds of large numbers
  of small savers, they can build their
  liquid-asset portfolios.
• Investor is also buying managerial expertise.