Good day sir Moffat
sir i am slightly confused about the explanation u have provided earlier.
why is it that we’ll be getting interest on the whole 1.5 million at the start of the year? Arent we going to sell off $150,000’s worth of investment at the beginning of the year itself to finance our cash requirements at the beg. months? And in that case,wont we just be getting interest on $1.35m?
also 5.2 weeks before the year end, wont we have sold the last $150,000 and hence receive no more interest?

Sir in that case, since the amount of investment on which we are earning interest is decreasing from $1.35m to 0 over the year,shouldnt we be calculating the average by (1.35m / 2)?
I am having difficulty grasping the logic behind d average computation shown

Just wanted to ask are all interest charges (per day) on overdrafts charged by taking the amount overdrawn by the end of day multiplied by the interest rate? (or for F9 purposes at least?

Good day Mr. Moffat, I still don’t get the reason why when it was time to do the average we kept doing 150000+1500000÷2 and 100000+1500000÷2. Instead of simply 1500000÷2.. I would appreciate if you can kindly shed more light on that. Thank you.

At the start of the year they have investment of 1,500,000 earning interest.
This amount is falling gradually over the year.
If it fell to zero by the end of the year, then the average amount on which interest is earned would be 1,500,000 / 2 = 750,000

If it falls to 150,000 by the end of the year, then the average amount on which interest is earned would be slightly higher: (1,500,000 + 150,000) / 2

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..

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%.

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?

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.

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.

sayma says

Good day sir Moffat

sir i am slightly confused about the explanation u have provided earlier.

why is it that we’ll be getting interest on the whole 1.5 million at the start of the year? Arent we going to sell off $150,000’s worth of investment at the beginning of the year itself to finance our cash requirements at the beg. months? And in that case,wont we just be getting interest on $1.35m?

also 5.2 weeks before the year end, wont we have sold the last $150,000 and hence receive no more interest?

John Moffat says

That is true and the way Baumol takes the average is only a rough approximation.

sayma says

Sir in that case, since the amount of investment on which we are earning interest is decreasing from $1.35m to 0 over the year,shouldnt we be calculating the average by (1.35m / 2)?

I am having difficulty grasping the logic behind d average computation shown

sayma says

sorry i meant our investment is decreasing from $1.5 m to 0.

therefore, shouldnt average be(1.5m/2) instead of

(1.5 m + 150000)/2?

John Moffat says

I can only repeat my previous reply. That is the way that we use the Baumol formula.

Ali Karmali says

Hi John.

Just wanted to ask are all interest charges (per day) on overdrafts charged by taking the amount overdrawn by the end of day multiplied by the interest rate? (or for F9 purposes at least?

John Moffat says

Yes (and usually in real life also )

Ali Karmali says

Hi John.

Conversely, Is the interest earned on a term deposited earned the same way, per day?

John Moffat says

Yes, but deposits are usually for fixed periods and usually at fixed interest.

Susan says

Good day Mr. Moffat, I still don’t get the reason why when it was time to do the average we kept doing 150000+1500000÷2 and 100000+1500000÷2. Instead of simply 1500000÷2.. I would appreciate if you can kindly shed more light on that. Thank you.

John Moffat says

At the start of the year they have investment of 1,500,000 earning interest.

This amount is falling gradually over the year.

If it fell to zero by the end of the year, then the average amount on which interest is earned would be 1,500,000 / 2 = 750,000

If it falls to 150,000 by the end of the year, then the average amount on which interest is earned would be slightly higher: (1,500,000 + 150,000) / 2

Ali Karmali says

But it does fall to zero at the end, doesnt it? I mean once u sell off the final 150

I dont get it.

John Moffat says

For the first month they would be earning interest on the full 1,500,000. In the last month they earn interest on 150,000.

Ali Karmali says

In other words, the remaining 150,000 will earn some interest by the time it is sold off and hence ghats makes the average higher?? Right?

John Moffat says

Right

javid 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..

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%.

javid says

Thank you for your reply.. god bless you. Very good explanation. Thank you.

siddharth says

sir , please can u explain y in transaction cost , even after we calculate 1.5M / 150000 .. we multiply 10 ??

John Moffat says

1.5M/150,000 = 10, so there are 10 transactions a year. Each transaction costs 150, so the total cost over the year is 10 x 150 = $1500.

Killqa 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

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.

sab says

Wow I liked that example.

Thank you so much for clarifying it…..

GOD you are so kind and so helpful!!

May God Bless You.

umer says

This explanation on how the average is calculated was really helpful. Thank you sir

ayeodele says

why is the average 150,000+1500,000/2 instead of 1500,000/2 not quite clear

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.