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The Miller Orr Model

In: Business and Management

Submitted By Nimila
Words 630
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The Miller Orr model * A more realistic alternative for Baumol model for cash management.
This model deals with managing daily cash. Miller-Orr says that daily cash flow deviation can be affected by the daily transaction cost, variance of cash flows and interest rates. Therefore, the spread formula is created to mean fluctuation. Lower limit (minimum cash balance) and upper limit (maximum cash balance) will be set and the spread causes the difference between lower limit and upper limit. In other word, Lower limit + spread = upper limit. The return point lies somewhere between lower limit and upper limit.
Under the model, the firm allows the cash balance to fluctuate between the upper control limit and the lower control limit, making a purchase and sale of marketable securities only when one of these limits is reached. The assumption made here is that the net cash flows are normally distributed with a zero value of mean and a standard deviation. This model provides two control limits – the upper control limit and the lower control limit as well as a return point. When the firm’s cash limit fluctuates at random and touches the upper limit, the firm buys sufficient marketable securities to come back to a normal level of cash balance i.e. the return point. Similarly, when the firm’s cash flows wander and touch the lower limit, it sells sufficient marketable securities to bring the cash balance back to the normal level i.e. the return point.

The lower limit is set by the firm based on its desired minimum “safety stock” of cash in hand The firm should also determine the following factors:
1. An interest rate for marketable securities, (i)
2. A fixed transaction cost for buying and selling marketable securities, (c)
3. The standard deviation if its daily cash flows, (s)
Graph Explanation:
When cash balance reaches point `A', the upper limit, company will invest the…...

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