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CA Intermediate · Financial Management and Strategic Management · Treasury and Cash Management

Under the Miller-Orr model, which of the following is correct?

The return point under Miller-Orr is the lower limit plus one-third of the spread between the upper and lower limits. Cash is brought back to this point when it touches either limit, and higher variance widens the spread, as the model assumes random cash flows.

  1. ACash is replenished each time the balance touches the upper limit
  2. BThe return point is the lower limit plus one-third of the spreadCorrect
  3. CThe spread between limits decreases when variance of daily cash flows increases
  4. DThe model assumes cash flows are perfectly predictable

Explanation

In Miller-Orr, the return point equals lower limit + (1/3) x spread, and the upper limit is lower limit + 3 x Z... wherein the spread is 3 x [(3/4 x transaction cost x variance)/interest rate]^(1/3). When the balance hits the upper limit, securities are bought to return to the return point, not replenished. The spread widens, not narrows, with higher variance, and the model is designed for unpredictable flows.

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