1. avatar says

    Hi john sir.. your lectures are brilliant and very entertaining thanks alot… i wanna ask you about interest earn on current balance. I understood when we withdraw or sell investment we loose interest but how does it affect on current asset. In above example we r given 2 interest rate 5 and 9%. Does it mean we put this investment money in a bank once we took it off from investment.. thank you in advance..

    • Profile photo of John Moffat says

      Because you sell investments in ‘lumps’ you do not spend it all at once. For example. you might sell 100,000 of investments each time. You will spend that 100,000 but spread over a few weeks, not all at once.
      As soon as you sell the investments you lose interest on the whole amount. Since you are not spending the amount all at once you will put it in an account to earn some interest (but at a much lower rate). So instead of losing all of the 9% you are only actually going to lose the difference of 4%.

  2. avatar says

    I read the comments left by ayeodele but I still can’t understand why the average amount of investment is 1,500,000 + 150,000 / 2… is there another way to explain this?

    Thank you very much

    • Profile photo of John Moffat says

      Suppose you start the day with $100 dollars in your pocket, and at the end of the day you have nothing left. Then on average you would have had 100/2 = $50.

      Suppose however the you start with $100 but at the end of the day you have still of $10 left. Surely on average you had a little more than before? On average it would be (100 + 10)/2 = $55.

      I hope that helps.

    • Profile photo of John Moffat says

      They are selling investments of 150,000 each time. Since in total they need 1,500,000 during the year (spread evenly) it means they will be making 10 sales – i.e. selling every 5.2 weeks.

      At the start of the year they will be receiving interest on the full 1.5M, but as they sell off investments the amount they will be receiving interest on keeps falling by 150,000 every 5.2 weeks. For the final 5.2 weeks they will only be receiving interest on the last 150,000.

      It is all very approximate to be honest (and to my mind rather stupid – I cannot see it being particularly useful in real life!).
      I think that is the reason why the examiner simply never asks Baumol calculations (years ago he used to give the formula on the formula sheet, but removed it – presumably because he is not going to ask you to use it).

      I really would not spend time on it. Just be aware of the idea, because it would be good to briefly mention it in a written part of a question if you are asked to write about ways of managing cash. I think I am correct in saying that the only times ever it has been mentioned in the exam are that twice (over a period of at least 15 years) the examiner has made a passing mention of it in his answer to a written part of a question. He didn’t explain the technique – just mentioned it as being available :-)
      Miller Orr is far more practical and more important for the exam.

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