Financial Analysis, Planning and
Forecasting
Theory and Application
Chapter 20
Cash, Marketable Securities, and Inventory Management
By
Alice C. Lee
San Francisco State University
John C. Lee
J.P. Morgan Chase
Cheng F. Lee
Rutgers University
Outline

20.1 Introduction

20.2 The Baumol and Miller-Orr model

20.3 Cash management systems

20.4 Credit lines and bank relations

20.5 Marketable securities management

20.6 Inventory Management

20.7 Summary

Appendix 20A. Derivation of equation 20-1
20.1 Introduction
20.2 The Baumol and Miller-Orr model
 Baumol’s
EOQ model
 Miller-Orr
model
20.2 The Baumol and Miller-Orr model
EOQ  C 
Figure 20-1
2 FT
k
（20-1）
20.2 The Baumol and Miller-Orr model
Figure 20-2
20.2 The Baumol and Miller-Orr model
2  $120  $1,560,000 
C 
 $55,857
.12


C $55,857

 $27,928.50
2
2
20.2 The Baumol and Miller-Orr model
Figure 20-3
20.2 The Baumol and Miller-Orr model
 3 F 2 
S  3

4
k


1
3
（20-2）
S
R L
3
（20-3）
H SL
（20-4）
4R  L
ACB 
3
（20-5）
20.2 The Baumol and Miller-Orr model
 3  20  9, 000, 000 
spread  3 

4

.000329


1
3
 $22, 293
upper limit = lower limit + spread
= ＄20,000＋＄22,293
= ＄42,293
 22,293 
return point = 20,000 + 
  $ 27, 431
 3 
average cash balance =
4  $27, 431  $20,000
3
 $ 29,908
20.3 Cash management systems

Float

Cash collection and transference systems

Cash transference mechanism and scheduling
20.3 Cash management systems
Figure 20-4
20.3 Cash management systems
Figure 20-5
Source: Stone and Hill, 1980.
20.3 Cash management systems
Figure 20-6
Source: Stone and Hill, 1980.
20.4 Credit lines and bank relations
 Credit
 Bank
lines
relations
20.4 Credit lines and bank relations
$112,000
 14%
$800,000
.14  $200, 000
 3.5%
$800,000
 $112,000  $28,000  17.5%
$800,000
elective interest cost =
 interest expense + implicit interest expense 
 line of credit limit - compensating balances 
20.5 Marketable securities management
 Investment
criteria for surplus cash
balances
 Types
of marketable securities
 Hedging
considerations
20.5 Marketable securities management
n
bond price = 
t=1
fixed interest payment
1+ί 
t

principal
1+ί 
n
$10,000 - price
365 days
annual yield 

price
days to maturity
$10, 000  9,500 365


 .1055
9,500
182
20.5 Marketable securities management
put hedge ratio = 1 - call hedge ratio
= 1 - N  d1 
ln  P E   rt   t 2
2
 t
(20-6)
20.6 Inventory Management
 Inventory
Loans
 Economic
order quantity
20.6 Inventory Management
2SO
Q 
C


Q 
（20-7）
2  50,000  200 
 1,000 units
20
20.7 Summary
Chapter 20 has examined various aspects of cash
and marketable security management. Two
techniques were discussed that can assist in the
estimation of an optimal level or range for the cash
balance; these were Baumol’s model and the
Miller-Orr model.
To make the cash collection system more efficient,
the firm can choose from various methods for
collecting or transferring cash and deciding when
to transfer it. Such cost minimization is ideal for
linear programming applications.
20.7 Summary
The credit line offers the firm a means of handling cash
variations caused by seasonal effects or unanticipated
events. Establishing good bank relations is an important
feature for any cash management system. However, bank
services do take on a cost, typically in the form of
compensating balances. While credit lines can be a good
investment for a bank, they can have detrimental effects on
the bank’s liquidity that could intensify any maturity gap
problems.
Efficient cash management ensures that surplus balances
are invested in marketable securities that meet minimum
standards for certainty of principal, maturity, liquidity, and
yield. In Chapter 20, we considered the hedge decision
from the cash manager’s perspective and gave various
examples of hedging applications. Optimal inventory
management was also briefly discussed.
Appendix 20A. Derivation of equation 20-1
total costs = holding cost + transaction cost
C
T
= k    F 
2
C
  total cost 
C
k T  F
 
0
2
2
C
k  FT  
2 FT

;C 
2
2
C
k
（20A-1）
（20A-2）