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

Under the Baumol model of cash management, which assumption is made about the firm's cash usage and the cost of converting securities into cash?

The Baumol model assumes cash is used at a steady, predictable rate and that each conversion of securities into cash carries a fixed cost. Because it is built on EOQ logic, random flows are not allowed; those are handled by the Miller-Orr model.

  1. ACash outflows are steady and certain, and the conversion cost per transaction is fixedCorrect
  2. BCash flows are random and follow a normal distribution, with a variable conversion cost
  3. CCash inflows exceed outflows each day, so no conversion is needed
  4. DConversion cost rises in proportion to the amount converted

Explanation

The Baumol model applies the inventory EOQ logic to cash. It assumes a constant, predictable rate of cash use and a fixed cost per conversion, plus a known opportunity cost of holding cash. Random flows belong to the Miller-Orr model, so option B is wrong.

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