In the management of cash and marketable securities why should the primary concern be for safety AND liquidity rather than profit maximization?

Answer 1

the firm may hold excess funds in anticipation of cash outlay.when funds are being held for other than immediate transaction purposes, they should be converted from cash into interest-earning marketable securities which should be of highest investment grade usually consist of treasury bills, commercial paper, certification of time deposits from commercial banks

realistically, management of cash and marketable securities cannot be separated. management of one implies management of other

reasons for holding marketable securities

there are several reasons for holding marketable securities such as

1. they serve as a substitute for cash balances

many firms prefer to hold marketable securities as a substitute for transaction balances, precautionary balances, for speculative balances of for all three. in most cases the securities are held primarily for precautionary purposes or as a guard against a possible shortage of bank credit.

2. they held as a temporary investment where a return is earned while funds are temporarily idle.

3. they are built up to meet known financial requirements such as tax payments, maturing bond issue and so on.

factors influencing the choice of marketable securities

among the factors that will influence the choice of marketable securities

1. risk such as

a. default risk. the risk that the issuer of the security can not pay the principal or interest at due dates.

b. interest rate risk. the risk of declines in market values of the security due to rising interest rate

c. inflation rate. the risk that inflation will reduce the real value of the investment. in periods of rising prices, inflation risk is lower on investments whose returns tend to rise with inflation than on investment whose return are fixed.

2. maturity

MARKETABLE SECURITIES held should mature or can be sold at the same time cost is required.

3. yield or returns on securities. generally, the higher a security's risk the higher its required return. corporate investors, like other investors must make a trade-off between risk and return when choosing marketable securities. because these securities are generally held either for specific known need or for use in emergencies, the portfolio should consist of highly liquid short-term securities issued by the government or very strong corporations. treasurers should not sacrifice safety for higher rates of return.

4. Marketability (liquidity) risk

this refers to the risk that securities cannot be sold at close to the quoted market price and is closely associated with liquidity risk.