Tony Quizlet
instruments
a class od similar investment. Examples are agency notes, commercial paper, treasury bills, certificates of deposits, bankers acceptance, and repurchase agreement.
thin market
one with little participation by buyers and/or sellers
breadth
refers to the number and size of parties which are potential buyers of the instruments in a market.
secondary market
exchange arena for securities subsequent to their original issue. Not every investor holds the security to maturity, necessitating a well-functioning market for resale.
variance
the amount by which the actual amount is over or under the forecasted or budgeted amount.
Contrast business risk and financial risk.
Business risk is the possibility that the company will be unable to meet ongoing operating expenditures, and financial risk is the possibility that the company will not be able to cover financing‐related expenditures such as lease payments, interest, principal repayment, and preferred stock dividends.
Why do corporations put so much emphasis on cash forecasting?
Cash forecasts are the most important tool for monitoring and controlling corporate cash. Without them, good cash management is simply impossible. First, cash forecasts drive the short-term investing and borrowing strategies. Knowing the maturity of a short-term investment, when to repay borrowings, or the size of a credit line to request all depend critically on the forecasted cash position. Alternating cash surpluses and shortages occur because cash receipts and disbursements are not synchronized. Second, the forecast is an important input into short-term financial policy decisions, including disbursement policies, credit terms, and bank selection: making decisions along the cash flow time line requires accurate estimation of flow size and timing. Third, cash forecasts function as a control device. Prior to the beginning of each year the forecasting staff will develop a cash budget, which is a forecast of cash flows and the cash balance for each month. As the year progresses, deviations of actual cash balances from cash budget projections signal the cash manager to investigate and take corrective action. Accurate forecasts can provide the company with added value when they signal a cash shortage and the need for proactive actions before the fact, or corrective actions as actual data becomes available and is compared to what was forecast.
How can a company's cash position be measured for forecasting purposes?
Generally, it is preferable to measure the company's available cash, which means we wish to forecast the available bank balance. The level of the bank balance (or balances, in the case of multiple accounts) is what triggers short-term investments or borrowings.
receipts and disbursement method
a commonly used cash forecasting approach which involves determining upcoming source of cash inflows and outflows, then laying these out on a schedule to see the aggregate effect.
primary market
also called the original issue, is centered in money centers such as New York City, London, Frankfurt, Singapore, and Hong Kong. Investors an access this 'over-the-counter' market from anywhere, as the market consists of phone and computer hook-ups among all participating dealers and brokers.
money market
arena in which buyers and sellers of all securities maturing in one year less interact; trading does not take place in any one physical location, but mainly by phone and computer communications. To distinguish the money market from capital markets, only securities with an original maturity of one year or less are included.
sensitivity analysis
means of incorporating risk in financial outcomes which involves varying key inputs, one at a time, and observing the effect on the decision variable(s). For example, the analyst might vary the sales level and observe the effect on the company's cash forecast.
Define prepayment risk
refers to a return of principal whenever a mortgage in the pool is paid off due to homeowner relocation or to a drop in general interest rates, which trigger refinancing.
private placement
security issuance transaction in which a large institution such as a retirement fund or insurance company buys the entire issue.
taxable instruments
security types which are not given preferential tax treatment, including commercial paper, domestic and Eurodollar certificates of deposits, banker's acceptance, repurchased agreements, and money market mutual funds invested in those instruments.
modified accrual method
sometimes called the "accrual add back technique" or "adjusted net income technique'" this cash forecasting approach begins with accounting reports or the operating budget and then adjust these numbers to reflect the timing of cash flows related to these transaction.
fed funds rate
the rate charged on reserve borrowings, most overnight,transacted between banks.
forecast interval
the units the horizon is segmented into, such as months in a year-ahead forecast.
tax advantaged instruments
those on which part or all of the income is exempted from taxation, or where the tax is deferred.
judgmental approach
A method of approving or denying credit based on the lender's judgment rather than on a particular credit scoring model.
List and explain briefly the advantage of pooling investors' monies in a market mutual fund.
1.professional money management, as professional money managers make the investment decisions and oversee the securities in the funds; 2.diversification of default risk by including many issuers' securities, and possibly even securities from issuers in various countries; 3. higher yields due to investing in much larger denominations than would be possible for any single investor; 4. enhanced liquidity because as some investors withdraw funds others are reinvesting, and individual securities do not have to be sold to fund withdrawals; and 5.greater flexibility in the sense that any combination of securities can be assembled--by maturity, issuer type, issuer geographic location, or other mixes investors might desire.
cash budget
A cash budget is a budget or plan of expected cash receipts and disbursements during the period. These cash inflows and outflows include revenues collected, expenses paid, and loans receipts and payments. In other words, a cash budget is an estimated projection of the company's cash position in the future.
Why is a company's forecast philosophy an important ingredient in determining potential forecast accuracy?
A company's forecasting philosophy affects the potential accuracy and usefulness of its cash forecasts and the techniques used in making the forecast. For example, some companies' staffs are quantitatively-oriented, and some use the judgmental (subjective) approach.
Explain how an RP works, and distinguish if from a sweep account.
A repurchase agreement (RP, or "repo") is the sale of a portfolio of securities with a prearranged buyback one or several days later. As the sale price is less than the repurchase price, the difference constitutes the interest return. Sweep accounts are those in which excess funds are automatically or at the cash manager's request transferred ("swept") from the demand deposit account into an interest-bearing overnight investment.
Are agency securities a creditworthy as treasury securities? Explain.
Agencies are securities issued by governmental agencies and several private financing institutions that have governmental backing. For a slightly higher default risk and less liquidity investors gain higher yields on federal agency securities than on Treasury securities with similar maturities.
What is the mathematical relationship between the discount yield and the coupon-equivalent yield?
Coupon-equivalent yield is calculated based on a 365-day year instead of 360 days which is the case for discount yield. It also bases the return on the amount invested, not the face value.
How do the roles of money market dealers and brokers differ?
Dealers typically "take a position" in the security instrument(s) they trade, meaning they hold an inventory of securities. Independent securities dealers, investment banks, and large commercial banks commonly have individuals that perform the dealer role. Brokers are also middlemen, but they do not inventory the securities they arrange transactions. When receiving an order, they check around for the security; when located, the brokers execute the trade. They are paid a commission for their services.
Distinguish between discount securities and coupon securities.
Discount securities do not pay coupon interest, meaning they are bought at a price below their face or par value and the investor receives face value at maturity. Coupon securities are bought at a given face value, on which the periodic interest is calculated. Interest may be added to the account within the holding period or at the end of that period.
Why would corporate investors use a dividend capture strategy? what is the major risks involved?
Dividend capture simply means buying a common or preferred stock shortly before it pays its dividend, or buying a preferred stock having an adjustable dividend payment. The major risk is a decline in the stock price during the holding period. This strategy uses high dividend paying stocks. Under tax law, these investments must be held for 46 days. Investing higher dollar amounts will enhance the return associated with this strategy because the commissions paid on a purchase can wipe out the excess return.
How can a liquidity assessment be conducted?
Dynamic liquidity indicators such as lambda and net liquid balance could be calculated and evaluated, and the analyst should project a Statement of Cash Flows for each of the next several years.
Why do Eurodollars Cps generally yield are than domestic negotiable CDs?
Eurodollar deposits are not assessed an FDIC premium, nor are they required to have reserves held against them. The lower costs to issuers imply higher yields than domestic CDs for the investor.
difference between daily and monthly forecasts
First, the time horizon differs. A daily forecast may be for the upcoming week or 10 days, but very rarely would it extend beyond the next 30 days. A monthly forecast typically extends to 6 or 12 months, and sometimes longer. Second, the techniques used to make daily forecasts differ from those most appropriate for the monthly interval. Forecasters typically use scheduling for daily cash forecasts, especially for short horizons. Statistical tools can be helpful for the recurrent, non-major elements in the forecast, however. Many smaller and some medium- sized companies do not even forecast on a daily basis, relying on funding from investments or credit lines to cover shortfalls. Monthly cash forecasting approaches are the receipts and disbursements method (sometimes referred to as scheduling), the modified accrual method, and the balance sheet projection method.
why do managers generally prefer using the available bank balance?
For most companies it is just too cumbersome to adjust the company's ledger cash balance as shown in its accounting records.
What are the key inputs that a company might use in developing the policy?
Inputs include the cash flow forecast, credit facility existence and amount, financial position, company risk assessment, liquidity assessment, and third‐party restrictions. An example of a third party restriction is a loan covenant which may prohibit or limit the types and amounts of certain risky investments.
Why is knowledge of the money market important for carrying out of value-maximizing short-term financial management?
Knowing the available investment options and how to evaluate them is important for three major reasons. First, improved cash management and forecasting ability has its payoff in increased interest income or reduced interest expense. Second, even where the company is a net borrower during much of the year, it still needs a liquidity reserve. Third, the corporate treasurer must understand the money markets because each investment represents someone else's borrowing. Learning about potential investments implies understanding when and how each security could be used as a way to borrow funds.
Of what relevance is either type of risk to the risk posture a company might take regarding short-term investments?
Larger cash and securities balances might be held by companies having significant exposure to either or both types of risk.
mixed approach
Mixed methods research is a methodology for conducting. research that involves collecting, analyzing, and integrating (or mixing) quantitative and qualitative research (and data) in a single study or a longitudinal program of inquiry.
Why is this an important prerequisite to determining the target mix of cash and marketable securities?
Most importantly, at a minimum the pattern of cash flows (including trend, cyclical, and seasonal components, as discussed in Chapter 12) and the variability of cash flows should be identified. Finally, stocks of liquid assets—particularly of cash and securities—and unused short‐term borrowing capacity should be incorporated into the comprehensive liquidity analysis. The cash management models such as the Baumol model (see Appendix 15A) are of limited assistance in setting the target cash and securities balance because they only consider the transactions demand for cash.
"The cash budget is just a glorified name for cash forecast." Comment on this statement, do you agree or not explain why you think this statement was made.
No. The cash budget is a document showing anticipated cash receipts and disbursements for a future period, usually one year. This cash budget is formulated to be consistent with the company's operating budget, which specifies planned sales and operating expenses. Once the budget year begins, two comparisons provide valuable information to management: (1) a comparison of actual cash versus budgeted cash for the most recent month and for the year to date, and (2) an updated cash forecast for the remainder of the year which includes an explanation of any variance relative to budgeted cash. It is thus a special form of cash forecast, in that it serves as a control device.
why does the primary market functionally depend on the secondary market?
Primary and secondary markets are inter-related because the larger the volume on the resale market, the less risk involved with buying the security on the primary market.
quantitive approach
Quantitative analysis involves using scientific or mathematical data to understand a problem, such as analyzing surveys to predict consumer demand. This contrasts with a qualitative approach, which uses a more social methodology, like interviewing people.
What is the difference between a primary and secondary market?
Securities with an original maturity sold in the primary market or a current maturity of one year or less bought on the secondary market are considered to be part of the money market. It is in the primary market that investment bankers arrange for the marketing and pricing of new issues of money market securities. The secondary market, even more so than the primary market, is best thought of as a global network of telecommunication hook- ups between all potential buyers and sellers.
Agency problems occur when managerial interest deviate from those of shareholders. Given that managers may be more interested in business and financial risk than systematic risk: a) How might this affect the short-term investments policy? b) What effect will this have on the investment returns earned?
Stockholders may elect to introduce monitoring, incentive, and control mechanisms such as stock option plans to realign managerial and stockholder interests. a) The policy may be less aggressive as manages seek to maintain job security and present compensation levels. b) There may be smaller returns relative to what shareholders could have achieved.
Explain the mechanics of interest rate resetting on variable rate demand notes.
The variable rate demand note reset interest rate is a function of supply and demand factors in this specialized market. If investors do not like the new rate, they can still sell ("put") the security back to the issuer for par value.
Why do large companies not use them as commonly as small companies?
They are used more often by smaller firms because they do not have the funds to invest in other money market securities due to their high minimum denomination.
Why are sweep accounts done with a company's deposit bank the most convent method of investing surplus cash balance?
Sweep accounts are those in which excess funds are automatically or at the cash manager's request transferred ("swept") from the demand deposit account into an interest-bearing overnight investment. Banks offer the convenience of "one-stop" shopping, automatic transfers of amounts above the compensating balance level, choices of several pooled investments to select from, and perhaps even an optional credit line paydown instead of investing the surplus. The bank merely makes a bookkeeping entry--no wire transfer is made--and the transaction can be fully automated by stipulating that any balances above some preset amount will be swept out nightly
depth
The amount of money or its asset equivalent to which a company, organisation or an individual person has access.
Given that the major concern short-term corporate investing is safety of principal, why are corporate investors buying insecure CP?
The high-quality issuers that have always been able to issue commercial paper have been joined by medium-quality issuers offering credit enhancement in the form of collateral or a backup line of credit from their banks. While default risks are measurably higher for either type of commercial paper issuer, the default rates are still extremely low.
What is an investment policy?
The investment policy defines the company's posture toward risk and return and specifies how it is to be implemented. A common risk perspective is the evaluative criterion of "safety, liquidity, yield," implying that risk aspects take precedence over return because of the importance of preserving the principal invested.
Summarize the theories regarding the term structure of interest rates.
The oldest explanation and first in importance is the unbiased expectations hypothesis. This theory posits that the prevailing yield curve is mathematically derived from the present short-term rate and expectations for rates that will exist at various points in time in the future. Existing interest rates in today's markets are called spot rates; rates that the market collectively forecast today for future years are called forward rates. Combining the shortest-term spot rates with the forward rates being forecasted by the market, we can derive today's spot rates for medium-term and long-term securities. The second explanation for a yield curve's shape is the liquidity preference hypothesis. Higher yields are viewed as necessary to induce investors to tie their funds up for long time periods (in other words, to be illiquid) in light of the increasing interest rate risk. Preference for liquidity is thought to characterize enough investors that the yield curve (in the absence of expectations or other influences on other than the shortest- term securities) should slope upward from left to right. The longer the maturity, the larger the liquidity premium that must be offered to attract investors. The market segmentation hypothesis contends that instead of being close substitutes, securities with short, medium, and long maturities are seen by investors (funds suppliers) and issuers (funds demanders) as quite different. Supply and demand in each maturity spectrum determines the prevailing interest rate in that spectrum, and market participants do not arbitrage disparities across spectrums. The fourth hypothesis merges unbiased expectations and liquidity preference in the biased expectations hypothesis. Basically this is merely expectations modified by some degree of liquidity preference. Many market observers find the biased expectations hypothesis the most plausible of the four explanations.
Define receipts and distribursement method
The receipts and disbursements method involves looking up most of the data variables in company sources, and estimating cash effect timing of noncash events. The major noncash events are product sales and material purchases. The forecaster then schedules the receipts and disbursements on a projected time line (some individuals have used desk calendars for this) according to anticipated cash flow dates. The steps involved with generating the cash forecast using the receipts and disbursements method are straightforward. First, the analyst must develop or look up the company's sales forecast. Preferably, a range of sales forecasts can be developed, linked to likely scenarios for the horizon period. Second, the analyst lays out the incoming cash from cash sales, cash collections, asset sales, and other sources. Third, cash disbursements related to payments to suppliers, employees, governments, and funds providers are arrayed. Weaknesses include the inaccuracy for forecast horizons above three months (largely due to the compounding of early errors) and the over-reliance on the forecaster's judgment that typifies real-life applications of the technique.
What constitutes a useful forecast?
The usefulness of a forecast involves more than its accuracy. A useful forecast: (1) allows for timely and appropriate managerial responses to foreseen cash surpluses or shortfalls, and (2) specifies the variability of the cash flows and cash position.
what does usefulness include beyond forecast accuracy?
The usefulness of a forecast involves more than its accuracy. A useful forecast: (1) allows for timely and appropriate managerial responses to foreseen cash surpluses or shortfalls, and (2) specifies the variability of the cash flows and cash position.
Compare and contrast the low-liquidity, moderate0liquidity, and high-liquidity strategies. a) Regardless of which strategy is used, what specifically is being determined? b) the riskiness of each strategy. c)the likely profitability or return for each strategy. d)What strategy would you recommend to a consumer goods company that is not currently facing any strong competition for its market position and is not likely to face strong competition in the near future? e)What additional information about the company mentioned in D would you collect if you were actually making this decision?
a, b, c) The relative amount of a company's assets held in the form of cash and short‐term investments. The lower the liquidity, the riskier the strategy, but also the higher the strategy's expected profitability (returns) because of relatively greater investment in high return‐on‐investment fixed assets (such as new product lines and new markets entered). The low liquidity strategyentails driving the investment in cash and securities to a minimum. Thus, as a proportion of total assets, cash and securities would be very small. Assuming the company does not subsequently over‐invest in inventories and receivables, this approach should enhance profitability while also increasing business risk. The moderate liquidity strategy implies a somewhat greater investment in cash and securities, with correspondingly lower risk and lower profitability as compared to the low liquidity strategy. The high liquidity strategy prescribes a higher proportion of assets being held in cash and securities. Risk of default on securities and of bankruptcy are reduced because of the greater liquidity cushion, but profitability is lower as well. d) Low liquidity strategy because of the low level of business risk, unless the company is very highly leveraged with debt. e) Salability of inventories and receivables (or the ability to securitize these), available credit lines, and other sources of untapped debt capacity should be considered.
What are the opportunity costs of not taking into account the risk-return tradeoffs of the various short term instrument
gnorance regarding money market concepts might result in potential risks and returns being improperly appraised, but more typically the opportunity cost is losing the chance to have a greater return.
Why do top management focus more on the monthly cash forecast than the daily forecasts?
he monthly cash forecast serves as a valuable planning tool for top-level managers. First, the typical billing and payment cycle in most industries is monthly. Second, the monthly interval is generally thought to be adequate for anticipating funding requirements.
forecast horizon
how far ahead the cash balance is being projected
discount rate
in a capital project evaluation, it is the opportunity cost of the use of funds, which is used to determine the present value of cash flows.
model estimation
include the selection of an appropriate forecasting techniques and model calibration
What happens if a company continually relies on inaccurate cash forecast?
irst, cash forecasts drive the short-term investing and borrowing strategies. Knowing the maturity of a short-term investment, when to repay borrowings, or the size of a credit line to request all depend critically on the forecasted cash position. Alternating cash surpluses and shortages occur because cash receipts and disbursements are not synchronized. Second, the forecast is an important input into short-term financial policy decisions, including disbursement policies, credit terms, and bank selection: making decisions along the cash flow time line requires accurate estimation of flow size and timing. Third, cash forecasts function as a control device. Prior to the beginning of each year the forecasting staff will develop a cash budget, which is a forecast of cash flows and the cash balance for each month.
market microstructure
is a branch of finance concerned with the details of how exchange occurs in markets. ... The major thrust of market microstructure research examines the ways in which the working processes of a market affects determinants of transaction costs, prices, quotes, volume, and trading behavior.
resiliency
is the ability to withstand life events that impact one's income and/or assets. Some financially stressful events, such as unemployment, divorce, disability, and health problems affect people individually.
Define interest rate risk
is the possibility that interest rates will increase, causing the prices of existing fixed-income securities to drop.
Define reinvestment rate risk
is the possibility that the investor will have to invest cash proceeds at a lower interest rate for the remainder of the predetermined investment horizon.
Define default risk
is the possibility that the issuer will not meet contractual obligations to pay interest or repay principal.
Define liquidity risk
is tied to the marketability of a security--the ability to sell quickly at or very near the current market price.
