CA Intermediate · Financial Management and Strategic Management · Treasury and Cash Management
Under the Miller-Orr model of cash management, if the variance of daily cash flows rises while all other inputs remain unchanged, the spread between upper and lower control limits will:
The spread between the upper and lower limits increases. In the Miller-Orr formula the spread is directly related to the cube root of the variance of daily cash flows, so more volatile cash flows require a wider band before the firm must rebalance cash.
- ADecrease
- BIncreaseCorrect
- CRemain unchanged
- DBecome zero
Explanation
Spread = 3 x (3/4 x transaction cost x variance / interest rate)^(1/3). The spread rises with variance, so greater uncertainty in cash flows requires wider control limits. Decrease would apply if variance fell.
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