Question 1

Section A

AlgoTrade LLC, a high-frequency trading firm, requires $2,000,000 in cash over the next year to cover operational expenses. The cost of converting marketable securities into cash is $50 per transaction. The firm can earn 5% per annum on its marketable securities.

Using the Baumol model, what is the optimal cash conversion amount (the economic order quantity for cash)?

Accepted Answer

Apply the Baumol model formula: Q = square root of [(2 * Cost per transaction * Annual cash demand) / Interest rate].

Question 2

What mistakes do candidates make on this ACCA question?

Accepted Answer

Using the interest rate as a whole number (5) instead of a decimal (0.05), or forgetting to take the square root.

How to approach this question

Full Answer

Common mistakes

Practice the full ACCA FM — Financial Management Practice Exam 6

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