Chapter 14. Liquidity, Cash, and Marketable Securities.

So far, we have endeavored to understand the valuation of a company under varying assumptions as to the perfection of capital markets. In this part, we shift our focus form property, plant and equipment, and long-term financing to current assets and to short- and intermediate-term financing.

LIQUIDITY AND ITS ROLE.
The term liquid assets is used to describe money and assets that are readily convertible into money. Liquidity has two dimensions:
(1) the time necessary to convert the asset into money and
(2) the degree of certainty associate with the conversion ratio, or price, realized for the asset.

Liquidity When Perfect Capital Markets Exist.
Perfect markets imply liquidity is not a thing of value. Investors can produce homemade liquidity by either selling assets, by running the company themselves, or by effecting a costless reorganization.

Liquidity Management with Imperfections.
There are two dimensions of bankruptcy costs. The first is the "short-fall", arising from the liquidation of assets at "distress" prices. The second is the out-of-pocket fees paid to lawyers, trustees in bankruptcy, referees, receivers, liquidators, and so forth.

Another imperfection has to do with contracting costs of managers, workers, suppliers, and customers, as they may require additional incentive the riskier the firm.

Therefore, by increasing liquidity you reduce the probabilities of bankruptcy or of higher risks that reflect into costs.

Benefits Relative to Cost.
Liquid assets, like all other assets, have to be financed. Accordingly, the cost of liquidity may be thought as the differential in interest earned on the investment of funds in liquid assets and the cost of financing. The optimal level of liquidity then could be determined by marginal analysis.


CASH MANAGEMENT AND COLLECTIONS.
The cash cycle begins with the payment for purchases and services and ends with the collection of receivables.

Firms will want to reduce float (the time during which payments received by the firm remain uncollected funds) as much as possible.

Transferring funds.
Increasing cash availability also involves moving funds among banks. There are two principal methods:
(1) wire transfers and
(2) electronic depository transfer check (processed through an automatic clearing house.

Concentration Banking.
Concentration banking is a means of accelerating the flow of funds of a firm by establishing strategic collection centers, so that mailing time of payments is reduced.

Lockbox System.
The purpose of a lockbox arrangement is to eliminate the time between the receipt of remittances by the company and their deposit in the bank.

Customers are billed with instructions to mail their remittances to the lockbox. The bank picks up the mail several times a day and deposits the checks in the company's account.

Preauthorized Checks.
A preauthorized check (PAC) arrangement is sometimes used to reduce mailing and processing time. It works well for certain large customers where payments of a fixed amount are required.


CONTROL OF DISBURSEMENTS.
Accelerating collections and slowing disbursements shorten the cash cycle and result in more usable funds.

Mobilizing Funds and Slowing Disbursements.
A company with multiple banks should be able to shift funds quickly to banks from which disbursements are made, to prevent excessive balances from building up temporarily in a particular bank.

A means for delaying disbursements is through the use of payable-through drafts, which are not payable on demand (the bank must present it to the issuer for acceptance).

By maximizing disbursement float, the firm can reduce the amount of cash it holds and employ these funds in more profitable ways. One firm's gain, however, is another firm's loss and supplier relations may be hurt.

Zero balance account.
To make transfers automatically into a payroll, dividend, or other special account, some companies employ a zero balance account (ZBA). In this case, one master disbursing account services all subsidiary accounts. At the end of each day, the bank automatically transfers just enough funds to cover the checks presented for collection. As a result, a zero balance is mantained in each of the special disbursing accounts.

Payroll and Dividend Disbursements.
Many companies mantain a separate account for payroll disbursements. Based on its experience, the firm should be able to construct a distribution of when, on average, checks are presented for collection to minimize the cash balance in the account.

Electronic Funds Transfers.
Accelerating collections and slowing disbursements increasingly are being done electronically. In addition to paying bills, electronic funds transfers (EFTs) can be used to deposit payrolls automatically in employee accounts, to pay taxes, and to make dividend and other payments.

Because of lack of size or efficiency, some companies outsource their payable operation to firms that focus their core competencies in finance, including electronics funds transfers.


INVESTMENT IN MARKETABLE SECURITIES.
The financial manager will want to invest the portion of liquid assets in excess of transactions cash needs. Marketable securities serve the liquidity needs of the firm.

Yields on marketable securities vary with differences in default risk, in marketability, in length of time to maturity, in coupon rate, and in taxability.

For accounting purposes marketable securities and time deposits are shown as "cash deposits" on the balance sheets if their original maturity is 3 months or less. Other marketable securities are shown as "short-term investments", assuming their maturity is less than 1 year.

Credit Risk.
Investors are said to demand a risk premium to invest in other than default-free securities (Treasury securities). Creditworthiness is frequently judge on the basis of security ratings.

Marketability.
Marketability of a security relates to the ability of the owner to convert it into cash. There are two dimensions interrelated: the price realized and the amount of time required to sell the asset (the cheaper, the faster it will sell).

Maturity.
Credit risk and maturity are the two most important features when it comes to investment.

In general, the longer the maturity, the greater the risk of fluctuation in the market value of the security.

Coupon Rate.
For a given fixed-income security, the lower the coupon rate, the greater the price change for a given shift in interest rates (as more of the total return to the investor is reflected in the principal payment at maturity).

Taxability.
Only interest income from state and local government securities is tax exempt; as a result, they sell in the market at lower yields to maturity than other securities. Under present law, capital gains arising from the sale of a security at a profit are taxed at the full corporate tax rate.

Types of Marketable Securities.
Money markets include instruments of shorter maturity, which are liquid.

Treasury securities. The principal securities issued are bills, tax anticipation bills, notes, and bonds.

Repurchase Agreements. The repurchase agreement, or repo, is the sale of short-term securities by the dealer to the investor, whereby the dealer agrees to repurchase the securities at a specified future time.

Agency Securities. Obligations of various agencies of the federal government are guaranteed by the agency issuing the security, but not by the U.S. government as such.

Bankers' Acceptances. Bankers' acceptances are drafts that are accepted by banks, and they are used in financing foreign and domestic trade. The creditworthiness of bankers' acceptances is judged by the bank accepting the draft, not the drawer.

Commercial Paper. Commercial paper consists of short-term unsecured promisory notes issued by finance companies and certain industrial concerns. Commercial paper can be sold either directly or through dealers.

Certificates of Deposit. A short-term investment, the certificate of deposit (CD) is evidence of the deposit of funds at a commercial bank for a specified period of time and at a specified rate of interest.

Eurodollars. Although most Eurodollars are deposited in Europe, the term applies to any dollar deposit in foreign banks or in foreign branches of U.S. banks.

Short-Term Municipals. State and local governments are increasingly providing securities tailored to the short-term investor. One is commercial paper type of instrument, where the interest rate is reset every week.

Floating-Rate Preferred Stock. Straight preferred stock is a perpetual security where the dividend can be omitted by the issuer when its financial condition deteriorates. For these reasons, we usually do not think of it as being suitable for the marketable security portfolio of a corporation. However, the corporate investor gains a considerable tax advantage, in that 70 percent of the preferred stock dividend is exempt from federal taxation.

Floating-rate preferred stock, as the name implies, provides a yield that goes up or down with money market rates.

One product in this vein is money market preferred stock (MMP). With MMP, an auction is held every 49 days. This provides the investor with liquidity and relative price stability as far as interest-rate risk goes.

Portfolio Management.
The decision to invest excess cash in marketable securities involves not only the amount to invest but also the type of security in which to invest.

If future cash-flow patterns are known with reasonable certainty and the yield curve is upward sloping in the sense of longer-term securities yielding longer-term securities yielding more than shorter-term ones, a company may wish to arrange its portfolio so that securities will mature approximately when the funds will be needed.

If the yield curve is downward sloping, the company may wish to invest in securities having maturities shorter than the intended holding period, then to reinvest at maturity.

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EJERCICIOS - Serie 2 - Capítulo 14