Marketable Securities

Realistically the management of cash and marketable securities cannot be separated-management of one implies management of the other. We focused on cash management. Now we turn to marketable securities.

Marketable securities typically provide much lower yields than operating assets. For example, recently Chrysler held a $8.7 billion portfolio of short-term marketable securities that yielded about 6 percent but its operating assets provided a return of about 14 percent. Why would a company such as Chrysler 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 telephone call. Moreover, while cash an most commercial checking accounts yield northing, 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, for precautionary balances for speculative balances or for all three. In most cases the securities are held primarily for precautionary purposes most firms prefer to rely on bank credit to make temporary transactions or to meet speculative needs, but they may still hold some liquid assets to guard against a possible shortage of bank credit.

A few years ago Chrysler had essentially no cash it was incurring huge losses and those losses had drained its cash account. Then a new management team took over improved operations and began generating positive cash flows, Chryslers cash (and marketable securities) was up to $8.7 billion, and analysts were forecasting a further buildup over the next year or so to more than $10 billion. Management indicated, in various statements, that the cash hoard was necessary to enable the company to weather the next downturn in auto sales.

Although setting the target cash balance is to a large extent judgmental analytical rules can be applied to help formulate better judgments. For example, years ago William Baumol recognized that the trade-off between cash and marketable securities is similar to the one firms face when setting the optimal level of inventory. Baumol applied the EOQ inventory model to determine the optimal level of cash balances, he suggested that cash holdings should be higher if costs are high and the time to liquidate marketable securities is long, but that those holdings should be lower if interest rates are low. His logic was that if it is expensive and time consuming to convert securities to cash and if securities do not earn much because interest rates are low, then it does not pay to hold securities as opposed to cash. It does pay to hold securities if interest rates are high and the securities can be converted to cash quickly and cheaply.