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CMA Intermediate · Financial Management and Business Data Analytics · Management of Cash and Cash Equivalents

Under the Baumol model applied to cash management, which action would reduce the optimal cash conversion size, i.e. the amount raised each time by selling securities?

A fall in the fixed cost per transaction reduces the optimal conversion size. Under Baumol, the optimal amount equals the square root of twice the annual requirement times the transaction cost divided by the interest rate, so a lower transaction cost lowers it.

  1. AA fall in the fixed cost per transactionCorrect
  2. BA rise in the annual cash requirement
  3. CA fall in the interest rate on marketable securities
  4. DA rise in the fixed cost per transaction

Explanation

Baumol's optimal size C = sqrt(2 x annual requirement x cost per transaction / interest rate). C falls when the transaction cost falls. A rise in requirement or a fall in interest rate raises C, and a rise in transaction cost also raises C.

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