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Baumol model

Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA FM Exams › Baumol model

  • This topic has 1 reply, 2 voices, and was last updated 10 years ago by John Moffat.
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  • October 6, 2015 at 9:14 am #275043
    alighere
    Participant
    • Topics: 47
    • Replies: 66
    • ☆☆

    Hi John.

    Please could you help me with the foll. statement:

    ‘If the balances held in a current account are kept as low as possible by frequent movements of cash in and out, in order to minimise the holding costs, this may lead to excessive transaction costs’

    I understand the need to maintain a low level of liquidity is to minimise the opportunity cost in holding cash, but what about the transaction costs? Also, the relationship between cost of holding cash and size of cash balance is inverted (like 1/x). Why is it that more cash means less transaction cost?

    October 6, 2015 at 10:18 am #275145
    John Moffat
    Keymaster
    • Topics: 57
    • Replies: 54764
    • ☆☆☆☆☆

    If you have higher balances in the current account then you need to sell investments less often and will therefore have lower transaction costs over the year.

    Conversely, if you keep low balances in the current account then you need to sell investments more often which means more transaction costs over the year (which is what the statement is saying).

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