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Finance: Liquidity concepts

1. Explain how rapidly expending sales can drain the cash resources of a firm.
2. Discuss the relative volatility of short-and long-term interest rates.
3. What is the significance to working capital management of matching sales and productions?
4. How is a cash budget used to help manage current assets?
5. "The most appropriate financing pattern would be one in which asst buildup and lengths of financing terms are perfectly matched". Discuss the difficulty involved in achieving this financing pattern.
6. By using long-term financing to finance part of temporary current assets, a firm may have less risk but lower returns than a firm with a normal financing plan. Explain the significance of this statement.
7. A firm that uses short-term financing methods for a portion of permanent current assets is assuming more risk but expects higher returns than a firm with a normal financing plan. Explain.
8. What does the term structure of interest rates indicates?
9. What are three theories for describing the shape of the term structure of interest rates (the yield curve)? Briefly describe each theory.
10. Since the mid-1960s, corporate liquidity has been declining. What reasons can you give for this trend?

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1. Explain how rapidly expending sales can drain the cash resources of a firm.
If the sales are growing rapidly, it will require more investment in inventory, work in progress and accounts receivables than before leading to higher investment in these assets. Thus, the amount of cash locked in current assets is higher than it is freed. So cash resources will be drained.

2. Discuss the relative volatility of short-and long-term interest rates.
Short term interest rates are highly volatile as it purely depends upon the liquidity situation of the market. However, the average level of short term interest rates is low. On the other hand, long term interest rates are more stable for two reasons. First, small changes in current market conditions do not have much impact on the yield of long-term assets (bonds) as the change is spread over a longer period. Second, long term financing can be held back in periods of liquidity crunch in market so sharp changes in long terms interest rates are avoided.

3. What is the significance to working capital management of matching sales and productions?
According to matching sales and production, both accounts receivable and inventory rise when sales increase as production increases. When sales rise faster than production, inventory declines and receivables rise. Thus, if provided guidelines to the managers to plan their working capital. Level production should be ...

Solution Summary

A paragraph or 3-4 ideas for each question.

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