3. Costs of Holding Cash C * Costs of holding cash Size of cash balance The investment income foregone when holding cash. Trading costs increase when the firm must sell securities to meet cash needs. Maroof Hussain Sabri Opportunity Costs Trading costs Total cost of holding cash
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6. The Baumol Model C * Size of cash balance The optimal cash balance is found where the opportunity costs equals the trading costs Maroof Hussain Sabri Trading costs F K T C 2 * Opportunity Costs K C 2
7. The Baumol Model Opportunity Costs = Trading Costs The optimal cash balance is found where the opportunity costs equals the trading costs Multiply both sides by C Maroof Hussain Sabri F C T K C 2 F T K C 2 2 K F T C 2 2 K TF C 2 *
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Editor's Notes
Multiply both sides by 2C, divide by K. Take a square root.
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