Miller-Orr Model – NBC Institute

FM – AUG 2022 – L2 – Q5 – Cash management | Foreign exchange risk and currency risk management | Working Capital Management

Analyzes cash management using the Miller-Orr model, explains motives for holding cash, and discusses the advantages of currency forwards over futures.

Question

a) Adjei Departmental Stores’ demand for cash has been quite volatile recently, with the standard deviation in daily cash demand rising to GH¢60,000. The managers of the company are therefore considering using the Miller-Orr model to manage its cash flows. The minimum cash balance would be set to GH¢300,000. The annual interest rate is expected to be 18.25% while the cost of trading investments in securities is GH¢10,000 per transaction.

Required:
i) Compute the cash return point. (4 marks)
ii) Compute the upper cash limit. (2 marks)
iii) Explain how the minimum cash limit, upper cash limit, and cash return point would be used to manage the cash balances of Adjei Departmental Stores. (3 marks)

b) The Founder of a growing technology company has questioned her Chief Finance Officer about the company’s holdings of cash in demand deposit accounts and on hand when the money could be invested in financial securities for returns.

Required:
Explain to the Founder THREE (3) motives for holding cash. (6 marks)

c) Serwaa Home Décor Ltd, a trading company based in Ghana, usually buys foreign currency to settle invoices for imports. The Treasury Manager is considering ways of hedging the company’s foreign currency risk exposures. After considering various options available to her, she has settled on both forwards and futures contracts.

Required:
Explain TWO (2) advantages of currency forwards over currency futures contract. (5 marks)

Answer

Find Related Questions by Tags, levels, etc.

Tags: Cash Flow Management, Currency Forwards and Futures, Miller-Orr Model
Level: Level 2

Topic: Cash management, Foreign exchange risk and currency risk management, Working Capital Management
Series: AUG 2022

FM – NOV 2021 – L2 – Q5 – Cash management

Application of the Miller-Orr model to determine cash levels, comparison with the Baumol model, and the differences between futures and forward contracts.

Question

You are the assistant to the Finance Manager of Horthman Holdings Ltd. The Directors of the company are reviewing the cash management practices of the company. The main concern is that excessive cash balances are held in non-interest-bearing demand deposit accounts for relatively long periods. Your boss has been asked to advise the Directors on the appropriate cash balance levels the company should keep and matters relating to the investment of excess cash.

To assist your boss, you analysed the company’s demand for cash over the last three years and looked for some financial market figures. On the usage of cash, you found that the company’s daily cash needs vary with a standard deviation of GH¢25,000. However, the annual demand for cash averages around GH¢65 million. Considering the results of your examination, your boss proposes that the minimum cash balance is set at GH¢100,000 going forward.

From your search on the financial markets, you found that the company can earn interest from investments in money market securities at an annual rate of 21.6% on an actual/360-day count convention. Also, you found out that the average transaction cost for trading investments in such money market securities is GH¢2,500.

Your boss recommends using the Miller-Orr model for determining the critical cash control levels and investment of temporary excess cash in money market securities.

Required:
a) Using the Miller-Orr model, determine the following:
i) The cash spread between the lower and upper cash limit. (3 marks)
ii) The cash return point. (2 marks)
iii) The cash level at which the company should invest excess cash. (2 marks)

b) The Chief Executive Officer (CEO) believes that the Baumol model is a simpler model than the Miller-Orr model, and your boss should consider recommending that to the Directors. Considering the information provided in the preamble, would you say that the Baumol Model would be more appropriate? Explain. (4 marks)

c) Your boss recommends that temporary excess cash be invested in money market securities. Explain TWO (2) conditions required when deciding on investing temporary excess cash. (4 marks)

d) Future contracts and forward contracts (more commonly referred to as futures and forwards) are used by businesses and investors to hedge against risks or speculate. Futures and forwards are examples of derivative assets that derive their values from underlying assets. Both contracts rely on locking in a specific price for a certain asset, but they have differences.

Required:
Explain FOUR (4) differences between futures and forwards. (5 marks)

Answer

Find Related Questions by Tags, levels, etc.

Tags: Baumol Model, Cash Flow Management, Cash Management, Forwards, Futures, Miller-Orr Model
Level: Level 2

Topic: Cash management
Series: NOV 2021

FM – AUG 2022 – L2 – Q5 – Cash management | Foreign exchange risk and currency risk management | Working Capital Management

Analyzes cash management using the Miller-Orr model, explains motives for holding cash, and discusses the advantages of currency forwards over futures.

Question

Required:
Explain to the Founder THREE (3) motives for holding cash. (6 marks)

Required:
Explain TWO (2) advantages of currency forwards over currency futures contract. (5 marks)

Answer

Find Related Questions by Tags, levels, etc.

Tags: Cash Flow Management, Currency Forwards and Futures, Miller-Orr Model
Level: Level 2

Topic: Cash management, Foreign exchange risk and currency risk management, Working Capital Management
Series: AUG 2022

FM – NOV 2021 – L2 – Q5 – Cash management

Application of the Miller-Orr model to determine cash levels, comparison with the Baumol model, and the differences between futures and forward contracts.

Question

Your boss recommends using the Miller-Orr model for determining the critical cash control levels and investment of temporary excess cash in money market securities.

c) Your boss recommends that temporary excess cash be invested in money market securities. Explain TWO (2) conditions required when deciding on investing temporary excess cash. (4 marks)

Required:
Explain FOUR (4) differences between futures and forwards. (5 marks)

Answer

Find Related Questions by Tags, levels, etc.

Tags: Baumol Model, Cash Flow Management, Cash Management, Forwards, Futures, Miller-Orr Model
Level: Level 2

Topic: Cash management
Series: NOV 2021

Question Tag: Miller-Orr Model

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FM – AUG 2022 – L2 – Q5 – Cash management | Foreign exchange risk and currency risk management | Working Capital Management

Analyzes cash management using the Miller-Orr model, explains motives for holding cash, and discusses the advantages of currency forwards over futures.

FM – NOV 2021 – L2 – Q5 – Cash management

Application of the Miller-Orr model to determine cash levels, comparison with the Baumol model, and the differences between futures and forward contracts.

FM – AUG 2022 – L2 – Q5 – Cash management | Foreign exchange risk and currency risk management | Working Capital Management

Analyzes cash management using the Miller-Orr model, explains motives for holding cash, and discusses the advantages of currency forwards over futures.

FM – NOV 2021 – L2 – Q5 – Cash management

Application of the Miller-Orr model to determine cash levels, comparison with the Baumol model, and the differences between futures and forward contracts.

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FM – AUG 2022 – L2 – Q5 – Cash management | Foreign exchange risk and currency risk management | Working Capital Management

Analyzes cash management using the Miller-Orr model, explains motives for holding cash, and discusses the advantages of currency forwards over futures.

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FM – NOV 2021 – L2 – Q5 – Cash management

Application of the Miller-Orr model to determine cash levels, comparison with the Baumol model, and the differences between futures and forward contracts.

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FM – AUG 2022 – L2 – Q5 – Cash management | Foreign exchange risk and currency risk management | Working Capital Management

Analyzes cash management using the Miller-Orr model, explains motives for holding cash, and discusses the advantages of currency forwards over futures.

You're reporting an error for "FM – AUG 2022 – L2 – Q5 – Cash management | Foreign exchange risk and currency risk management | Working Capital Management"

FM – NOV 2021 – L2 – Q5 – Cash management

Application of the Miller-Orr model to determine cash levels, comparison with the Baumol model, and the differences between futures and forward contracts.

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