1. Copyright  2002 by South-Western, a division of Thomson Learning TM Chapter 15 Short-Term Investment Strategy Order Order Sale Cash Placed Received Received Accounts Collection Accounts Collection Accounts Disbursement Time ==> Invoice Payment Cash Invoice Payment Cash Received Sent Paid Received Sent Paid Order Order Sale Cash Placed Received Received Accounts Collection Accounts Collection Accounts Disbursement Time ==> Invoice Payment Cash Invoice Payment Cash Received Sent Paid Received Sent Paid

2. Copyright  2002 by South-Western, a division of Thomson Learning TM Objectives v Define an investment policy and indicate what inputs are used to develop the policy v Describe the cash and securities allocation decision v Describe the investment decision-making process v Calculate portfolio return for the purpose of evaluating portfolio performance v Indicate how a portfolio manager might assess risk and return tradeoffs

3. Copyright  2002 by South-Western, a division of Thomson Learning TM Short-Term Investment Policy v Defines company’s posture toward risk and return and specifies how it is to be implemented v Possible elements include: –minimal acceptable security ratings –allocation percentage constraints –strategy limitations –maturity limits –authorization and approvals –portfolio performance evaluation

4. Copyright  2002 by South-Western, a division of Thomson Learning TM Cash and Securities Allocation Decision v Aggregate investment in cash and securities v Cash and securities mix

5. Copyright  2002 by South-Western, a division of Thomson Learning TM Investment Decision-Making Process v Outside management –Selecting portfolio manager –Evaluating portfolio performance v Internal portfolio management

6. Copyright  2002 by South-Western, a division of Thomson Learning TM Assembling the Portfolio v General risk-return factors –GNP –Industry-specific events –Interest rate trends v Risk factors revisited –Interrelationships among risk types –Uncertainty of risk estimates –Portfolio risk and the risk-return tradeoff –Assessing the risk-return tradeoff v Short-term investment strategies

7. Copyright  2002 by South-Western, a division of Thomson Learning TM Short-Term Investment Strategies v Passive strategies –buy-and-hold v Active strategies –historical yield spread analysis –riding the yield curve –dividend capture strategy –maturity extension swap –yield spread swap

8. Copyright  2002 by South-Western, a division of Thomson Learning TM Survey Evidence on Strategies v 47% were aggressive v 34% moderate v 17% conservative v 2% passive

9. Copyright  2002 by South-Western, a division of Thomson Learning TM Survey Evidence, continued v 74% of aggressive managers had 75% of excess cash invested v Passive managers only had 50% invested

10. Copyright  2002 by South-Western, a division of Thomson Learning TM Survey Evidence, continued v Aggressive managers ranked rate of return as most important attribute v Moderate and conservative managers ranked default risk as most important attribute

11. Copyright  2002 by South-Western, a division of Thomson Learning TM Survey Evidence, continued v Aggressive managers used riding the yield curve much more often (30% usage rate) than did moderate (24% usage rate) or conservative (9% usage rate) managers. v Most popular instruments used were Eurodollar certificates first followed by repurchase agreements and commercial paper.

12. Copyright  2002 by South-Western, a division of Thomson Learning TM Summary v Begin investment process by considering the cash forecast, the company’s financial position, and the investment policy. v Decide whether or not to use an outside manager. v The chapter concluded with profiles of passive and active investment strategies.

13. Copyright  2002 by South-Western, a division of Thomson Learning TM Appendix 15A Cash Management Models

14. Copyright  2002 by South-Western, a division of Thomson Learning TM Cash & Securities Mix Decisions v Baumol v Miller-Orr v Stone

15. Copyright  2002 by South-Western, a division of Thomson Learning TM Baumol v Company receives funds periodically, but must disburse monies at a continuous steady rate v Cash needs are perfectly anticipated v Cash balances are replenished by a sale of securities v Similar to the EOQ model Time $ Z Z = (2*F*TCN / k) 1/2

16. Copyright  2002 by South-Western, a division of Thomson Learning TM Miller-Orr v Assumes cash flow is unpredictable v Permits both upward and downward movements in the cash balance UCL LCL LCL + Z $ Time Z = (3F  2 /4i) 1/3 UCL = 3Z + LCL

17. Copyright  2002 by South-Western, a division of Thomson Learning TM Stone v Allows for the cash manager’s knowledge of imminent cash flows to override model directives. v Similar to Miller-Orr in that it has UCL and LCL v...but before a transaction is made, the expected cash balance is compared to the UCL and LCL and a transaction is made ONLY if the EXPECTED cash balance is beyond these trigger points.

18. Copyright  2002 by South-Western, a division of Thomson Learning TM Stone, continued U C L L C L T i m e $ I f the daily cash balance hits UCL or LCL then estimate the cash balance in k days. Then, if the expected cash balance in k days is > adjusted UCL buy secs. If < adjusted LCL then sell secs.