ch27

Student: _______________________________________________________________________________________

Multiple Choice Questions

1. Financial managers broaden their definition of cash to include:

A. currency, bank deposits, stocks and bonds.

B. currency, checking deposits, undeposited checks, and bonds.
C. cash, bonds, bank deposits and short-term marketable securities.
D. currency, checking deposits, undeposited checks and short-term marketable securities.
E. None of the above.

2. Examples of cash disbursements do not include:

A. wages.
B. payment for raw materials.
C. taxes.
D. dividends.
E. sales of assets.

3. The Baumol model determines the optimal cash balance by:

A. balancing total costs against opportunity costs.

B. minimizing total costs of holding cash against trading securities costs.
C. balancing trading securities costs against total costs.
D. minimizing total costs less trading costs.
E. None of the above.

4. Which of the following is not an important characteristic of short-term marketable securities?

A. Maturity risk
B. Marketability
C. Taxability
D. Default risk
E. All of the above are important.

5. Marketability risk is synonymous with:

A. maturity risk.
B. default risk.
C. liquidity risk.
D. interest rate risk.
E. None of the above.

6. Which of the following money-market securities has no active secondary market?

A. Certificates of deposit (CD's)
B. Commercial paper
C. Banker's acceptances
D. Treasury bills
E. All money-market securities have active secondary markets.

7. If a firm has achieved its target cash balance the net present value is:

A. positive because the cash balance is positive.

B. zero because increasing the cash balance increases the interest cost.
C. negative because the cash balance has a financing cost.
D. positive because decreasing the cash decreases the cost of illiquidity.
E. None of the above.

8. Determining the appropriate target cash balance involves assessing the trade-off between:

A. income and diversification.

B. the benefit and cost of liquidity.
C. of balance sheet strength and transaction needs.
D. All of the above.
E. None of the above.

9. The target cash balance is reached when:

A. the interest on any marketable security throw-off is maximized.

B. the interest foregone from not investing in an equivalent amount of Treasury bills is minimized.
C. the value of cash liquidity equals interest foregone on an equivalent amount of Treasury bills.
D. the liquidity value is greater than interest foregone on an equivalent amount of Treasury bills.
E. None of the above.

10. Firms would need to hold zero cash when transactions related needs are:

A. greater than cash inflows.

B. less than cash inflows.
C. not perfectly synchronized with cash inflows.
D. perfectly synchronized with cash inflows.
E. None of the above.

11. Firms hold cash to satisfy the transaction motive. This means that cash is held:

A. to meet disbursements for normal operations.

B. to balance the flow between cash inflows and outflows.
C. to make unexpected payments such as special price discounts.
D. Both A and B.
E. None of the above.

12. Firms hold cash, in part, to satisfy compensating balances. Compensating balances are:

A. cash balances held at the firm in excess of its transactions needs.

B. cash balances held at the firm that are below that of its transactions needs.
C. cash balances held at the firm in excess of its cash inflows.
D. cash balances held at commercial banks to pay implicitly for bank services.
E. None of the above.

13. In determining the firms target cash balance, trading costs:

A. tend to fall when cash balances are large.

B. tend to rise when cash balances are large.
C. tend to rise when cash balances are low.
D. Both A and B.
E. Both A and C.

14. The cost of holding cash:

A. is the opportunity cost of lost return.

B. zero because it is the most liquid and desirable asset.
C. increases as cash holdings increase.
D. Both A and B.
E. Both A and C.

15. Concerning the Baumol model, which of the following is not correct (all other things equal)?

A. The optimum cash balance is higher the higher are interest rates.
B. The optimum cash balance is higher the higher are fixed order costs.
C. The optimum cash balance is higher the higher is the firm's total cash requirement.
D. Two of the above are not correct.
E. All of the above are correct.

16. The Baumol model determines the optimal cash balance by:

A. balancing total costs against opportunity costs.

B. minimizing total costs of holding cash against trading securities costs.
C. balancing trading securities costs against total costs.
D. minimizing total costs less trading costs.
E. None of the above.

17. The Baumol cash balance model is limited by:

A. assuming the cash flows are variable across the period.

B. a smooth disbursement rate and no cash inflows over the period.
C. having a safety stock set to zero.
D. Both A and C.
E. Both B and C.

18. In contrast to the Baumol model, the Miller-Orr model:

A. includes both cash inflows and outflows.

B. assumes that the distribution of daily cash flows is normally distributed.
C. allows the cash inflows and outflows to fluctuate randomly from day to day.
D. All of the above.
E. None of the above.

19. The lower cash limit, L, and the upper limit, H, are:

A. set by the firm and solved in the Miller-Orr model respectively.

B. both are solved for in the Miller-Orr model.
C. both set by the firm and only the target cash balance is solved for in the Miller-Orr model .
D. two random variables and need not be solved for.
E. None of the above.

20. The lower limit, L, and the upper limit, H, are:

A. just outside points but no transaction are made.

B. the points at which Z – L securities are sold and H – Z securities are bought.
C. the points are which Z – L securities are bought and H – Z securities are sold.
D. the points at which Z –L is transacted but any value above Z is held.
E. None of the above.

21. To be able to use the Miller-Orr model, a manager must not:

A. estimate the standard deviation of daily cash flows and the interest rate.
B. determine the average number of transactions.
C. estimate the trading costs of security transactions.
D. determine a lower control limit for cash.
E. None of the above.

22. A firm with low cash balances will need to borrow to cover an unexpected cash outflow:

A. if it has high cash flow variability.

B. if COGS decrease.
C. if the firm maintains a zero lower control limit.
D. Both A and B.
E. Both A and C.

23. Most large firms hold a cash balance greater than most models imply because:

A. it is too difficult to estimate the costs of security transactions.

B. banks are compensated by account balances for payment of services.
C. corporations have few bank accounts and it is difficult to manage their cash.
D. cash is costless and need not be managed closely.
E. None of the above.

24. The difference between bank cash and book cash is called:

A. float.
B. disbursement float.
C. net float.
D. collection float.
E. None of the above.
25. Checks written by the firm are said to generate:

A. collection float.
B. ledger float.
C. disbursement float.
D. book float.
E. None of the above.

26. When a firm writes a check, there is an immediate decrease in _____ cash, but no immediate change
in _____ cash.

A. bank; collected
B. ledger; book
C. bank; ledger
D. book; bank
E. None of the above

27. Collection float increases:

A. disbursement float.
B. bank cash.
C. book cash.
D. net float.
E. None of the above.

28. A financial manager should be concerned about bank cash and net float, which is the sum of:

A. collection and book cash.

B. collection float and disbursement float.
C. disbursement float and book cash.
D. disbursement float and bank credit.
E. None of the above.

29. Which of the following is not true of float management?

A. Float management involves controlling the collection and disbursement of cash.

B. An objective of float management is to speed up the collection float.
C. An objective of float management is to slow down disbursement float.
D. Float management will succeed if the firm can collect late and pay early.
E. All of the above are true of float management.

30. By getting closer to the source of payment, lockboxes can be used to reduce:

A. availability or clearing float.

B. mail float.
C. in-house processing float.
D. disbursement float.
E. None of the above.

31. The most common cash management technique used to speed up collections is:
A. concentration banking.
B. wire transfers.
C. lockboxes.
D. in-house processing.
E. None of the above.

32. The fastest but most expensive way to transfer surplus funds from the local deposit bank to the
concentration bank is:

A. a lockbox system.
B. a mail float system.
C. a wire transfer.
D. an in-house processing float system.
E. an availability float system.

33. Which of the following statements concerning zero balance accounts is not correct?

A. They are set up to handle disbursement activity.

B. The account has a minimum amount at all times.
C. Checks are automatically transferred into the account as checks presented for payment.
D. The transfer is automatic and involves an accounting entry only.
E. The master and the zero balance account locate at the same bank.

34. Efficient funds management attempts to reduce mailing and clearing time. Two methods do this by:

A. moving collections and deposits closer together in concentration banks; and moving surplus funds
quickly by wire transfers.
B. moving mailing points to cross country locations and using depository drafts to transfer funds.
C. drawing checks against zero balance accounts and using cross country mailing.
D. wiring funds to zero balance accounts and using lockboxes in many cities.
E. None of the above.

35. The major difference between a check and a draft is that:

A. the draft is not drawn on the bank but on the issuer.

B. the bank must present the draft to the firm for acceptance.
C. after acceptance the firm must deposit the funds to make payment.
D. All of the above.
E. None of the above.

36. If the total long term financing of the firm is greater than the total financing needs for part of the
year and less than the needs for some of the year due to seasonal fluctuations the company will most
likely:

A. hold excess cash.

B. borrow short term and hold excess cash.
C. hold excess cash and reduce business activities.
D. invest in marketable securities and borrow short term.
E. None of the above.
37. Adjustable rate preferred stock (ARPS) offer competitive rates of return with traditional money-
market instruments but:

A. are not rated by Moody's or Standard & Poor's.

B. still provide the corporate investor with the tax exclusion on dividend income.
C. have a fixed rate of dividend income.
D. offers a highly competitive trading market.
E. None of the above.

38. Even though the dividend rate on an Adjustable-Rate Preferred Stock (ARPS) is floating to keep in
line with interest rates, the instrument still suffers from risk such as:

A. a thin market causing potential principal risk and liquidity concerns.

B. the risk of downgrades from the narrow range of issuers.
C. the impact of tax law changes, which may reduce the after-tax value of the instrument.
D. All of the above.
E. None of the above.

39. Auction-Rate Preferred Stock is similar to Adjustable-Rate Preferred Stock (ARPS) in that they:

A. are both issued for 90 days.

B. have a dividend rate set by the issuer.
C. both have a floating rate and a dividend tax exclusion.
D. are equally accessible to the corporate investor directly.
E. are not similar in any manner.

40. Auction-Rate Preferred Stock has less risk factors than Adjustable-Rate Preferred Stock (ARPS)
because:

A. the reset period is 49 days instead of 90.

B. the market sets the dividend level reducing principle volatility.
C. better liquidity allows corporate investors to control their investments individually.
D. All of the above.
E. None of the above.

41. Floating rate CD's differ from regular CD's in that:

A. they have longer maturity.

B. they differ substantially in default risk.
C. they are not taxed.
D. they have coupons that are frequently reset.
E. All of the above describe differences.

The Timberline firm expects a total need of $12,500 over the next 3 months. They have a beginning
cash balance of $1,500, and cash is replenished when it hits zero. The fixed cost of selling securities
to replenish cash balances is $3.50. The interest rate on marketable securities is 8% per annum.
There is a constant rate of cash disbursement and no cash receipts during the month.
42. Based on the firm's current practice, what is the average daily cash balance (a month has 30 days)?

A. $50.00
B. $69.44
C. $94.44
D. $138.89
E. None of the above.

43. Based on the firm's current practice, how many times during the next 3 months will the cash balance
be replenished?

A. 3.33 times
B. 4.42 times
C. 8.33 times
D. 13.35 times
E. None of the above.

44. What is the total opportunity cost for a month based on the firm's current practice?

A. $5.00
B. $18.98
C. $27.92
D. $60.00
E. None of the above.

45. What is the total fixed order cost for the next three months based on the firm's current practice?

A. $29.17
B. $37.80
C. $55.60
D. $75.60
E. None of the above.

46. Using the Baumol model, what is the optimum cash holding?

A. $362.28
B. $1,045.83
C. $1,251.86
D. $3,613.82
E. None of the above.

47. What is the total saving to the firm if it switches from its current practice to the optimum practice (as
given by the Baumol model)?

A. $9.99
B. $34.20
C. $64.96
D. $122.46
E. None of the above.

48. If interest rates were to rise to 12.00% per annum, what would be the firm's optimum cash balance
using the Baumol model?
A. $295.81
B. $853.91
C. $1,024.70
D. $2,958.04
E. None of the above.

49. If interest rates were to rise to 1.00% per month, what would the firm's total savings be if it switches
from its current practice to the optimum practice (as given by the Baumol model)?

A. $4.62
B. $7.09
C. $26.42
D. $28.13
E. None of the above.

50. A firm uses the Miller-Orr model with a minimum balance of $10, a maximum of $80, and a target
balance of $40. If the cash balance was to hit $10, what would the firm do?

A. Buy $10 in marketable securities.

B. Buy $30 in marketable securities.
C. Sell $30 in marketable securities.
D. Sell $60 in marketable securities.
E. None of the above.

On an average day, a company writes checks totaling $1,500. These checks take 7 days to clear. The
company receives checks totaling $1,800. These checks take 4 days to clear. The cost of debt is 9%.
51. What is the firm's disbursement float?

A. $-10,500
B. $-8,700
C. $1,800
D. $10,500
E. None of the above.

52. What is the firm's collection float?

A. $-7,200
B. $-1,800
C. $1,800
D. $10,500
E. None of the above.

53. What is the firm's net float?

A. $-3,300
B. $-300
C. $300
D. $3,300
E. None of the above.
54. If the average daily float is $3,300, what is the net present value per day?

A. $-0.81
B. $-79.41
C. $-282.48
D. $-297.00
E. None of the above.

55. Your firm has average daily receipts of $2,500. These receipts are available after 6 days on average.
The interest rate that could be earned is .02% (.0002) per day. What is the approximate cost of the
float per day?

A. $2.50
B. $3.00
C. $30.00
D. $50.00
E. None of the above.

56. Your firm receives 40 checks per month. Of these, 10 are for $1,200 and 30 are for $500. The delay
for the $1,200 checks is 4 days; the $500 checks are delayed 6 days. What is the weighted average
delay?

A. 4 days
B. 4.5 days
C. 5 days
D. 5.5 days
E. 6 days

57. Your firm receives 10 checks per month. Of these, 6 are for $1,000 and 4 are for $500. The delay for
the $1,000 checks is 5 days, and the $500 checks are delayed 8 days. Calculate the average daily
float.

A. $1,533.33
B. $1,486.87
C. $1,500.00
D. $1,530.35
E. $1,590.04

Essay Questions
58. Fly-By-Night Airlines currently has $2.4 million on deposit with its bank. Fly-By-Night pays its fuel
bill by writing a check for $1.1 million. Calculate the company's book cash and bank cash after it
writes the check.

59. Harmony Corporation has a variance of daily cash flow of $8. The daily interest rate is .021%
 (.00021). Harmony desires a minimum cash balance of $80. The fixed cost of a security transaction
is $2.00. Using the Miller-Orr model, calculate Harmony's target cash balance, the upper limit on
cash balances, and the average daily cash balance. Explain how this is used to manage cash.

60. During the month you receive 4 checks, one for $100, two for $200, and one for $500. They are
delayed for 2 days, 4 days, and 8 days respectively. What is your average daily collection float (a
month has 30 days)?

The Mesa Bank is offering your company the use of their lockbox services. They estimate that you
can reduce your average mail time by 2 days and they can save you a combined clearing and
processing time of 1.5 days by putting the checks into the clearing system sooner. The firm receives
320 checks a day on average written for $2,500. The current T-Bill rate is 4% or .0107% per day.
61. What is the savings float and what can you earn if the firm takes Mesa's lockbox service?

62. If Mesa will charge your firm an annual fee of $ 35,000 and $ .20 per check handled will you accept
Mesa's services?

63. The net float of a firm is made up of disbursement float and collection float. Discuss the three
components of collection float and how they would work against the firm.

64. Discuss the Check Clearing Act for the 21st Century, known as Keck 21 and how it will impact
floats.
 ch27 KEY
Multiple Choice Questions
1. Financial managers broaden their definition of cash to include:

A. currency, bank deposits, stocks and bonds.

B. currency, checking deposits, undeposited checks, and bonds.
C. cash, bonds, bank deposits and short-term marketable securities.
D. currency, checking deposits, undeposited checks and short-term marketable securities.
E. None of the above.
Difficulty level: Medium
Ross - Chapter 27 #1
Topic: CASH

2. Examples of cash disbursements do not include:

A. wages.
B. payment for raw materials.
C. taxes.
D. dividends.
E. sales of assets.
Difficulty level: Easy
Ross - Chapter 27 #2
Topic: CASH DISBURSEMENTS

3. The Baumol model determines the optimal cash balance by:

A. balancing total costs against opportunity costs.

B. minimizing total costs of holding cash against trading securities costs.
C. balancing trading securities costs against total costs.
D. minimizing total costs less trading costs.
E. None of the above.
Difficulty level: Medium
Ross - Chapter 27 #3
Topic: BAUMOL MODEL

4. Which of the following is not an important characteristic of short-term marketable securities?

A. Maturity risk
B. Marketability
C. Taxability
D. Default risk
E. All of the above are important.
Difficulty level: Easy
Ross - Chapter 27 #4
Topic: MARKETABLE SECURITIES

5. Marketability risk is synonymous with:

A. maturity risk.
B. default risk.
C. liquidity risk.
D. interest rate risk.
E. None of the above.
Difficulty level: Easy
Ross - Chapter 27 #5
Topic: MARKETABILITY RISK

6. Which of the following money-market securities has no active secondary market?

A. Certificates of deposit (CD's)

B. Commercial paper
C. Banker's acceptances
D. Treasury bills
E. All money-market securities have active secondary markets.
Difficulty level: Medium
Ross - Chapter 27 #6
Topic: COMMERCIAL PAPER

7. If a firm has achieved its target cash balance the net present value is:

A. positive because the cash balance is positive.

B. zero because increasing the cash balance increases the interest cost.
C. negative because the cash balance has a financing cost.
D. positive because decreasing the cash decreases the cost of illiquidity.
E. None of the above.

Difficulty level: Medium

Ross - Chapter 27 #7
Topic: TARGET CASH BALANCE

8. Determining the appropriate target cash balance involves assessing the trade-off between:

A. income and diversification.

B. the benefit and cost of liquidity.
C. of balance sheet strength and transaction needs.
D. All of the above.
E. None of the above.
Difficulty level: Medium
Ross - Chapter 27 #8
Topic: TARGET CASH BALANCE

9. The target cash balance is reached when:

A. the interest on any marketable security throw-off is maximized.

B. the interest foregone from not investing in an equivalent amount of Treasury bills is minimized.
C. the value of cash liquidity equals interest foregone on an equivalent amount of Treasury bills.
D. the liquidity value is greater than interest foregone on an equivalent amount of Treasury bills.
E. None of the above.
Difficulty level: Medium
Ross - Chapter 27 #9
Topic: TARGET CASH BALANCE

10. Firms would need to hold zero cash when transactions related needs are:
A. greater than cash inflows.
B. less than cash inflows.
C. not perfectly synchronized with cash inflows.
D. perfectly synchronized with cash inflows.
E. None of the above.
Difficulty level: Medium
Ross - Chapter 27 #10
Topic: TARGET CASH BALANCE

11. Firms hold cash to satisfy the transaction motive. This means that cash is held:

A. to meet disbursements for normal operations.

B. to balance the flow between cash inflows and outflows.
C. to make unexpected payments such as special price discounts.
D. Both A and B.
E. None of the above.
Difficulty level: Medium
Ross - Chapter 27 #11
Topic: TRANSACTIONS BALANCE

12. Firms hold cash, in part, to satisfy compensating balances. Compensating balances are:

A. cash balances held at the firm in excess of its transactions needs.

B. cash balances held at the firm that are below that of its transactions needs.
C. cash balances held at the firm in excess of its cash inflows.
D. cash balances held at commercial banks to pay implicitly for bank services.
E. None of the above.
Difficulty level: Easy
Ross - Chapter 27 #12
Topic: COMPENSATING BALANCE

13. In determining the firms target cash balance, trading costs:

A. tend to fall when cash balances are large.

B. tend to rise when cash balances are large.
C. tend to rise when cash balances are low.
D. Both A and B.
E. Both A and C.
Difficulty level: Easy
Ross - Chapter 27 #13
Topic: TARGET CASH BALANCE

14. The cost of holding cash:

A. is the opportunity cost of lost return.

B. zero because it is the most liquid and desirable asset.
C. increases as cash holdings increase.
D. Both A and B.
E. Both A and C.

Difficulty level: Medium

Ross - Chapter 27 #14
Topic: COST OF HOLDING CASH
15. Concerning the Baumol model, which of the following is not correct (all other things equal)?

A. The optimum cash balance is higher the higher are interest rates.
B. The optimum cash balance is higher the higher are fixed order costs.
C. The optimum cash balance is higher the higher is the firm's total cash requirement.
D. Two of the above are not correct.
E. All of the above are correct.
Difficulty level: Medium
Ross - Chapter 27 #15
Topic: BAUMOL MODEL

16. The Baumol model determines the optimal cash balance by:

A. balancing total costs against opportunity costs.

B. minimizing total costs of holding cash against trading securities costs.
C. balancing trading securities costs against total costs.
D. minimizing total costs less trading costs.
E. None of the above.
Difficulty level: Medium
Ross - Chapter 27 #16
Topic: BAUMOL MODEL

17. The Baumol cash balance model is limited by:

A. assuming the cash flows are variable across the period.

B. a smooth disbursement rate and no cash inflows over the period.
C. having a safety stock set to zero.
D. Both A and C.
E. Both B and C.
Difficulty level: Challenge
Ross - Chapter 27 #17
Topic: BAUMOL MODEL

18. In contrast to the Baumol model, the Miller-Orr model:

A. includes both cash inflows and outflows.

B. assumes that the distribution of daily cash flows is normally distributed.
C. allows the cash inflows and outflows to fluctuate randomly from day to day.
D. All of the above.
E. None of the above.
Difficulty level: Easy
Ross - Chapter 27 #18
Topic: MILLER-ORR MODEL

19. The lower cash limit, L, and the upper limit, H, are:

A. set by the firm and solved in the Miller-Orr model respectively.

B. both are solved for in the Miller-Orr model.
C. both set by the firm and only the target cash balance is solved for in the Miller-Orr model .
D. two random variables and need not be solved for.
E. None of the above.
 Difficulty level: Challenge
Ross - Chapter 27 #19
Topic: MILLER-ORR MODEL

20. The lower limit, L, and the upper limit, H, are:

A. just outside points but no transaction are made.

B. the points at which Z – L securities are sold and H – Z securities are bought.
C. the points are which Z – L securities are bought and H – Z securities are sold.
D. the points at which Z –L is transacted but any value above Z is held.
E. None of the above.
Difficulty level: Challenge
Ross - Chapter 27 #20
Topic: MILLER-ORR MODEL

21. To be able to use the Miller-Orr model, a manager must not:

A. estimate the standard deviation of daily cash flows and the interest rate.
B. determine the average number of transactions.
C. estimate the trading costs of security transactions.
D. determine a lower control limit for cash.
E. None of the above.
Difficulty level: Challenge
Ross - Chapter 27 #21
Topic: MILLER-ORR MODEL

22. A firm with low cash balances will need to borrow to cover an unexpected cash outflow:

A. if it has high cash flow variability.

B. if COGS decrease.
C. if the firm maintains a zero lower control limit.
D. Both A and B.
E. Both A and C.
Difficulty level: Medium
Ross - Chapter 27 #22
Topic: CASH BALANCE

23. Most large firms hold a cash balance greater than most models imply because:

A. it is too difficult to estimate the costs of security transactions.

B. banks are compensated by account balances for payment of services.
C. corporations have few bank accounts and it is difficult to manage their cash.
D. cash is costless and need not be managed closely.
E. None of the above.
Difficulty level: Medium
Ross - Chapter 27 #23
Topic: CASH BALANCE

24. The difference between bank cash and book cash is called:

A. float.
B. disbursement float.
C. net float.
D. collection float.
E. None of the above.
Difficulty level: Easy
Ross - Chapter 27 #24
Topic: FLOAT

25. Checks written by the firm are said to generate:

A. collection float.
B. ledger float.
C. disbursement float.
D. book float.
E. None of the above.
Difficulty level: Easy
Ross - Chapter 27 #25
Topic: DISBURSEMENT FLOAT

26. When a firm writes a check, there is an immediate decrease in _____ cash, but no immediate change
in _____ cash.

A. bank; collected
B. ledger; book
C. bank; ledger
D. book; bank
E. None of the above
Difficulty level: Easy
Ross - Chapter 27 #26
Topic: DISBURSEMENT FLOAT

27. Collection float increases:

A. disbursement float.
B. bank cash.
C. book cash.
D. net float.
E. None of the above.
Difficulty level: Easy
Ross - Chapter 27 #27
Topic: COLLECTION FLOAT

28. A financial manager should be concerned about bank cash and net float, which is the sum of:

A. collection and book cash.

B. collection float and disbursement float.
C. disbursement float and book cash.
D. disbursement float and bank credit.
E. None of the above.
Difficulty level: Medium
Ross - Chapter 27 #28
Topic: COLLECTION FLOAT AND DISBURSEMENT FLOAT
29. Which of the following is not true of float management?

A. Float management involves controlling the collection and disbursement of cash.

B. An objective of float management is to speed up the collection float.
C. An objective of float management is to slow down disbursement float.
D. Float management will succeed if the firm can collect late and pay early.
E. All of the above are true of float management.
Difficulty level: Easy
Ross - Chapter 27 #29
Topic: FLOAT MANAGEMENT

30. By getting closer to the source of payment, lockboxes can be used to reduce:

A. availability or clearing float.

B. mail float.
C. in-house processing float.
D. disbursement float.
E. None of the above.
Difficulty level: Easy
Ross - Chapter 27 #30
Topic: LOCKBOX

31. The most common cash management technique used to speed up collections is:

A. concentration banking.
B. wire transfers.
C. lockboxes.
D. in-house processing.
E. None of the above.
Difficulty level: Easy
Ross - Chapter 27 #31
Topic: LOCKBOX

32. The fastest but most expensive way to transfer surplus funds from the local deposit bank to the
concentration bank is:

A. a lockbox system.
B. a mail float system.
C. a wire transfer.
D. an in-house processing float system.
E. an availability float system.
Difficulty level: Easy
Ross - Chapter 27 #32
Topic: WIRE TRANSFER

33. Which of the following statements concerning zero balance accounts is not correct?

A. They are set up to handle disbursement activity.

B. The account has a minimum amount at all times.
C. Checks are automatically transferred into the account as checks presented for payment.
D. The transfer is automatic and involves an accounting entry only.
E. The master and the zero balance account locate at the same bank.
 Difficulty level: Medium
Ross - Chapter 27 #33
Topic: ZERO BALANCE ACCOUNTS

34. Efficient funds management attempts to reduce mailing and clearing time. Two methods do this by:

A. moving collections and deposits closer together in concentration banks; and moving surplus funds
quickly by wire transfers.
B. moving mailing points to cross country locations and using depository drafts to transfer funds.
C. drawing checks against zero balance accounts and using cross country mailing.
D. wiring funds to zero balance accounts and using lockboxes in many cities.
E. None of the above.
Difficulty level: Challenge
Ross - Chapter 27 #34
Topic: FUNDS MANAGEMENT

35. The major difference between a check and a draft is that:

A. the draft is not drawn on the bank but on the issuer.

B. the bank must present the draft to the firm for acceptance.
C. after acceptance the firm must deposit the funds to make payment.
D. All of the above.
E. None of the above.
Difficulty level: Medium
Ross - Chapter 27 #35
Topic: CHECKS AND DRAFTS

36. If the total long term financing of the firm is greater than the total financing needs for part of the
year and less than the needs for some of the year due to seasonal fluctuations the company will most
likely:

A. hold excess cash.

B. borrow short term and hold excess cash.
C. hold excess cash and reduce business activities.
D. invest in marketable securities and borrow short term.
E. None of the above.

Difficulty level: Challenge

Ross - Chapter 27 #36
Topic: SEASONAL FLUCTUATIONS AND CASH MANAGEMENT

37. Adjustable rate preferred stock (ARPS) offer competitive rates of return with traditional money-
market instruments but:

A. are not rated by Moody's or Standard & Poor's.

B. still provide the corporate investor with the tax exclusion on dividend income.
C. have a fixed rate of dividend income.
D. offers a highly competitive trading market.
E. None of the above.
Difficulty level: Medium
Ross - Chapter 27 #37
Topic: ADJUSTABLE RATE PREFERRED STOCK

38.
Even though the dividend rate on an Adjustable-Rate Preferred Stock (ARPS) is floating to keep in
 line with interest rates, the instrument still suffers from risk such as:

A. a thin market causing potential principal risk and liquidity concerns.

B. the risk of downgrades from the narrow range of issuers.
C. the impact of tax law changes, which may reduce the after-tax value of the instrument.
D. All of the above.
E. None of the above.
Difficulty level: Challenge
Ross - Chapter 27 #38
Topic: ADJUSTABLE RATE PREFERRED STOCK

39. Auction-Rate Preferred Stock is similar to Adjustable-Rate Preferred Stock (ARPS) in that they:

A. are both issued for 90 days.

B. have a dividend rate set by the issuer.
C. both have a floating rate and a dividend tax exclusion.
D. are equally accessible to the corporate investor directly.
E. are not similar in any manner.
Difficulty level: Medium
Ross - Chapter 27 #39
Topic: ADJUSTABLE RATE PREFERRED STOCK

40. Auction-Rate Preferred Stock has less risk factors than Adjustable-Rate Preferred Stock (ARPS)
because:

A. the reset period is 49 days instead of 90.

B. the market sets the dividend level reducing principle volatility.
C. better liquidity allows corporate investors to control their investments individually.
D. All of the above.
E. None of the above.
Difficulty level: Medium
Ross - Chapter 27 #40
Topic: ADJUSTABLE RATE PREFERRED STOCK

41. Floating rate CD's differ from regular CD's in that:

A. they have longer maturity.

B. they differ substantially in default risk.
C. they are not taxed.
D. they have coupons that are frequently reset.
E. All of the above describe differences.
Difficulty level: Easy
Ross - Chapter 27 #41
Topic: CERTIFICATES OF DEPOSIT

The Timberline firm expects a total need of $12,500 over the next 3 months. They have a beginning
cash balance of $1,500, and cash is replenished when it hits zero. The fixed cost of selling securities
to replenish cash balances is $3.50. The interest rate on marketable securities is 8% per annum.
There is a constant rate of cash disbursement and no cash receipts during the month.
Ross - Chapter 27

42. Based on the firm's current practice, what is the average daily cash balance (a month has 30 days)?
A. $50.00
B. $69.44
C. $94.44
D. $138.89
E. None of the above.

Average daily cash balance = [(($12,500/3)+$1,500)/2]/30 = $94.44

Difficulty level: Medium
Ross - Chapter 27 #42
Topic: AVERAGE CASH BALANCE

43. Based on the firm's current practice, how many times during the next 3 months will the cash balance
be replenished?

A. 3.33 times
B. 4.42 times
C. 8.33 times
D. 13.35 times
E. None of the above.

Replenish Times = Cash Needs/Cash Balance = $12,500/$1,500 = 8.33 times

Difficulty level: Medium
Ross - Chapter 27 #43
Topic: CASH BALANCE

44. What is the total opportunity cost for a month based on the firm's current practice?

A. $5.00
B. $18.98
C. $27.92
D. $60.00
E. None of the above.

Opportunity cost = (C/2)(K) = ($1,500/2)(.006667) = $5.00

Difficulty level: Medium
Ross - Chapter 27 #44
Topic: OPPORTUNITY COST OF HOLDING CASH

45. What is the total fixed order cost for the next three months based on the firm's current practice?

A. $29.17
B. $37.80
C. $55.60
D. $75.60
E. None of the above.

Total Fixed Order Cost = ($12,500/$1,500)(3.5) = $29.17

Difficulty level: Easy
Ross - Chapter 27 #45
Topic: TOTAL FIXED ORDER COST
46. Using the Baumol model, what is the optimum cash holding?

A. $362.28
B. $1,045.83
C. $1,251.86
D. $3,613.82
E. None of the above.
Difficulty level: Medium
Ross - Chapter 27 #46
Topic: OPTIMAL CASH BALANCE

47. What is the total saving to the firm if it switches from its current practice to the optimum practice (as
given by the Baumol model)?

A. $9.99
B. $34.20
C. $64.96
D. $122.46
E. None of the above.
Difficulty level: Medium
Ross - Chapter 27 #47
Topic: OPTIMUM CASH BALANCE

48. If interest rates were to rise to 12.00% per annum, what would be the firm's optimum cash balance
using the Baumol model?

A. $295.81
B. $853.91
C. $1,024.70
D. $2,958.04
E. None of the above.
Difficulty level: Medium
Ross - Chapter 27 #48
Topic: OPTIMUM CASH BALANCE

49. If interest rates were to rise to 1.00% per month, what would the firm's total savings be if it switches
from its current practice to the optimum practice (as given by the Baumol model)?

A. $4.62
B. $7.09
C. $26.42
D. $28.13
E. None of the above.
Difficulty level: Medium
Ross - Chapter 27 #49
Topic: OPTIMUM CASH BALANCE

50. A firm uses the Miller-Orr model with a minimum balance of $10, a maximum of $80, and a target
balance of $40. If the cash balance was to hit $10, what would the firm do?

A. Buy $10 in marketable securities.

B. Buy $30 in marketable securities.
C. Sell $30 in marketable securities.
D. Sell $60 in marketable securities.
E. None of the above.

Sell Z - L = $40 - $10 = $30 in marketable securities.

Difficulty level: Medium
Ross - Chapter 27 #50
Topic: MILLER-ORR MODEL

On an average day, a company writes checks totaling $1,500. These checks take 7 days to clear. The
company receives checks totaling $1,800. These checks take 4 days to clear. The cost of debt is 9%.
Ross - Chapter 27

51. What is the firm's disbursement float?

A. $-10,500
B. $-8,700
C. $1,800
D. $10,500
E. None of the above.

DF = number of days times amount per day = 7 ($1,500) = $10,500

Difficulty level: Easy
Ross - Chapter 27 #51
Topic: DISBURSEMENT FLOAT

52. What is the firm's collection float?

A. $-7,200
B. $-1,800
C. $1,800
D. $10,500
E. None of the above.

CF = Days x Amount/Day = 4 ($-1,800) = $-7,200

Difficulty level: Easy
Ross - Chapter 27 #52
Topic: COLLECTION FLOAT

53. What is the firm's net float?

A. $-3,300
B. $-300
C. $300
D. $3,300
E. None of the above.

DF + CF = $10,500 - $7,200 = $3,300

Difficulty level: Easy

Ross - Chapter 27 #53
Topic: NET FLOAT
54. If the average daily float is $3,300, what is the net present value per day?

A. $-0.81
B. $-79.41
C. $-282.48
D. $-297.00
E. None of the above.

NPV = $3,300/(1 + .09/365) - $3,300 = $3,299.19 - $3,300 = $-0.81

Difficulty level: Challenge
Ross - Chapter 27 #54
Topic: FLOAT

55. Your firm has average daily receipts of $2,500. These receipts are available after 6 days on average.
The interest rate that could be earned is .02% (.0002) per day. What is the approximate cost of the
float per day?

A. $2.50
B. $3.00
C. $30.00
D. $50.00
E. None of the above.

Present value of delayed float = $2,500/(1+.0002(6)) = $2,497

Difficulty level: Medium
Ross - Chapter 27 #55
Topic: FLOAT COST

56. Your firm receives 40 checks per month. Of these, 10 are for $1,200 and 30 are for $500. The delay
for the $1,200 checks is 4 days; the $500 checks are delayed 6 days. What is the weighted average
delay?

A. 4 days
B. 4.5 days
C. 5 days
D. 5.5 days
E. 6 days

(.25)(4 days) + (.75)(6 days) = 5.5 days

Difficulty level: Medium
Ross - Chapter 27 #56
Topic: WEIGHTED AVERAGE DELAY

57. Your firm receives 10 checks per month. Of these, 6 are for $1,000 and 4 are for $500. The delay for
the $1,000 checks is 5 days, and the $500 checks are delayed 8 days. Calculate the average daily
float.

A. $1,533.33
B. $1,486.87
C. $1,500.00
D. $1,530.35
E. $1,590.04

Total Float = $1,000 (6) (5) + $500 (4) (8) = $46,000

Difficulty level: Medium

Ross - Chapter 27 #57
Topic: AVERAGE DAILY FLOAT

Essay Questions
58. Fly-By-Night Airlines currently has $2.4 million on deposit with its bank. Fly-By-Night pays its fuel
bill by writing a check for $1.1 million. Calculate the company's book cash and bank cash after it
writes the check.

Book Cash = $2.4 - $1.1 = $1.3 million

Bank Cash = $2.4 - $0.0 = $2.4 million

Ross - Chapter 27 #58

59. Harmony Corporation has a variance of daily cash flow of $8. The daily interest rate is .021%
(.00021). Harmony desires a minimum cash balance of $80. The fixed cost of a security transaction
is $2.00. Using the Miller-Orr model, calculate Harmony's target cash balance, the upper limit on
cash balances, and the average daily cash balance. Explain how this is used to manage cash.

.3333
Z* = [(3) ($2) ($8) / (4) (.00021)] + 80 = $118.52
H* = 3 ($118.52) -$ 2($80) = $195.56
Average Daily Cash Balance = [(4) ($118.52) - $80] / 3 = $131.36
If cash rises above $195.56 marketable securities are bought to bring the cash down to $118.52. If cash
fall below $80 then marketable securities are sold to bring the cash balance up to $118.52.

Ross - Chapter 27 #59

60. During the month you receive 4 checks, one for $100, two for $200, and one for $500. They are
delayed for 2 days, 4 days, and 8 days respectively. What is your average daily collection float (a
month has 30 days)?

[100 (2) + 200 (4) (2) + 500 (8)] / 30 = 5800/30 = $193.33

Ross - Chapter 27 #60

The Mesa Bank is offering your company the use of their lockbox services. They estimate that you
can reduce your average mail time by 2 days and they can save you a combined clearing and
processing time of 1.5 days by putting the checks into the clearing system sooner. The firm receives
320 checks a day on average written for $2,500. The current T-Bill rate is 4% or .0107% per day.
Ross - Chapter 27

61. What is the savings float and what can you earn if the firm takes Mesa's lockbox service?

Total days of float saved = 2 + 1.5 = 3.5 days

Dollars of float saved = 3.5($800,000) = $ 2,800,000
Earnings = $2,800,000(.000107)(365) = $ 109,354
Ross - Chapter 27 #61
62. If Mesa will charge your firm an annual fee of $ 35,000 and $ .20 per check handled will you accept
Mesa's services?

Cost of services: Annual fee = $35,000

Variable fee ($.20)(320)(365) = $23,360
Total fees = $58,360
Total earnings = $109,354 [= $2,800,000(.000107)(365)]
Net earnings = $ 50,994 Accept Mesa's services.
Ross - Chapter 27 #62

63. The net float of a firm is made up of disbursement float and collection float. Discuss the three
components of collection float and how they would work against the firm.

(1) Mail float--based on time checks pass through the postal system.
(2) In-house processing float--time receiver takes to process and deposit check in bank.
(3) Availability Float--time to clear banking system and have use of funds.
They work against the firm by increasing the time until final payment and use of funds.
Systems can be placed internally and externally to move checks into clearing system faster.
Ross - Chapter 27 #63

64. Discuss the Check Clearing Act for the 21st Century, known as Keck 21 and how it will impact
floats.

Check 21 was enacted on October 29, 2004 and should dramatically reduce floats. Formerly, for a check
to clear, the receiver had to send the check to the issuing bank for clearance. Under Check 21, an
electronic copy of the check is sent and clearing times have reduced dramatically. Formerly, out-of-state
checks would take 3 days to clear, with Check 21, they take 1 day. This will have impact on float
management as funds are nearly immediately released and disburse.
Ross - Chapter 27 #64
 ch27 Summary
Category # of Questions
Difficulty level: Challenge 8
Difficulty level: Easy 19
Difficulty level: Medium 30
Ross - Chapter 27 67
Topic: ADJUSTABLE RATE PREFERRED STOCK 4
Topic: AVERAGE CASH BALANCE 1
Topic: AVERAGE DAILY FLOAT 1
Topic: BAUMOL MODEL 4
Topic: CASH 1
Topic: CASH BALANCE 3
Topic: CASH DISBURSEMENTS 1
Topic: CERTIFICATES OF DEPOSIT 1
Topic: CHECKS AND DRAFTS 1
Topic: COLLECTION FLOAT 2
Topic: COLLECTION FLOAT AND DISBURSEMENT FLOAT 1
Topic: COMMERCIAL PAPER 1
Topic: COMPENSATING BALANCE 1
Topic: COST OF HOLDING CASH 1
Topic: DISBURSEMENT FLOAT 3
Topic: FLOAT 2
Topic: FLOAT COST 1
Topic: FLOAT MANAGEMENT 1
Topic: FUNDS MANAGEMENT 1
Topic: LOCKBOX 2
Topic: MARKETABILITY RISK 1
Topic: MARKETABLE SECURITIES 1
Topic: MILLER-ORR MODEL 5
Topic: NET FLOAT 1
Topic: OPPORTUNITY COST OF HOLDING CASH 1
Topic: OPTIMAL CASH BALANCE 1
Topic: OPTIMUM CASH BALANCE 3
Topic: SEASONAL FLUCTUATIONS AND CASH MANAGEMENT 1
Topic: TARGET CASH BALANCE 5
Topic: TOTAL FIXED ORDER COST 1
Topic: TRANSACTIONS BALANCE 1
Topic: WEIGHTED AVERAGE DELAY 1
Topic: WIRE TRANSFER 1
Topic: ZERO BALANCE ACCOUNTS 1