606 CHAPTER 16 Working Capital Management
What is meant by the term “permanent NOWC”?
What is meant by the term “temporary NOWC”?
What are three alternative short-term financing policies? Is one best?Short-Term Investments: Marketable Securities
Realistically, the management of cash and marketable securities cannot be separated —
management of one implies management of the other. In the first part of the chapter,
we focused on cash management. Now, we turn to marketable securities.
Marketable securities typically provide much lower yields than operating assets.
For example, recently DaimlerChrysler held approximately a $7 billion portfolio of
short-term marketable securities that provided a much lower yield than its operating
assets. Why would a company such as DaimlerChrysler have such large holdings of
low-yielding assets?
In many cases, companies hold marketable securities for the same reasons they
hold cash. Although these securities are not the same as cash, in most cases they can be
converted to cash on very short notice (often just a few minutes) with a single tele-
phone call. Moreover, while cash and most commercial checking accounts yield noth-
ing, marketable securities provide at least a modest return. For this reason, many firms
hold at least some marketable securities in lieu of larger cash balances, liquidating part
of the portfolio to increase the cash account when cash outflows exceed inflows. In
such situations, the marketable securities could be used as a substitute for transactions
balances or for precautionary balances. In most cases, the securities are held primarily
for precautionary purposes — most firms prefer to rely on bank credit to make tempo-
rary transactions, but they may still hold some liquid assets to guard against a possible
shortage of bank credit during difficult times.
There are both benefits and costs associated with holding marketable securities.
The benefits are twofold: (1) the firm reduces risk and transactions costs because it
won’t have to issue securities or borrow as frequently to raise cash; and (2) it will have
ready cash to take advantage of bargain purchases or growth opportunities. Funds
held for the second reason are called speculative balances.The primary disadvantage
is that the after-tax return on short-term securities is very low. Thus, firms face a
trade-off between benefits and costs.
Recent research supports this trade-off hypothesis as an explanation for firms’ cash
holdings.^14 Firms with high growth opportunities suffer the most if they don’t have
ready cash to quickly take advantage of an opportunity, and the data show that these
firms do hold relatively high levels of marketable securities. Firms with volatile cash
flows are the ones most likely to run low on cash, so they tend to hold high levels of cash.
In contrast, cash holdings are less important to large firms with high credit ratings, be-
cause they have quick and inexpensive access to capital markets. As expected, such firms
hold relatively low levels of cash. Of course, there will always be outliers such as Ford,
which is large, strong, and cash-rich, but volatile firms with good growth opportunities
are still the ones with the most marketable securities, on average.Why might a company hold low-yielding marketable securities when it could
earn a much higher return on operating assets?(^14) See Tim Opler, Lee Pinkowitz, René Stulz, and Rohan Williamson, “The Determinants and Implications
of Corporate Cash Holdings,” Journal of Financial Economics,Vol. 52, 1999, 3–46.