Question

3.

A. What techniques can a firm use to optimize demand deposit holdings?

B. How do a firm’s current asset investment policies impact the firm’s ROE? (For example: how would a restricted investment policy affect ROE, versus a relaxed policy?)

Answer 1

A) Techniques to optimize demand deposit holdings:

1) Hold marketable securities rather than demand deposits to provide liquidity

2) Forecast payments and receipts in a better way

3) Spped up payments

4) Use credit cards, debit cards, wire transfers etc.

5) Borrow on short notice

B) In restricted investment policy, current assets for achieving targeted revenue are estimated aggresively without considering for any contingency and provision of any unforseeable event. Adopting such policy results in lower working capital requirement due to lower level of current assets required. This saves interest expense for the company thereby increasing the RoE.

In relaxed policy, which is just the opposite of restricted policy, the current assets for achieving the targeted revenue are estimated after considering uncertain events such as seasonlity, a sudden change in the level of activities or sales etc. The disadvantage with such a policy is that it requires higher investment which attracts higher interest thereby pulling down the overall RoE.