Assume that the nominal interest rate in an economy is 3 percent and the cost of going to the ATM is $1.50. You spend $5 each day, and there is also a 12 percent probability of having your cash lost or stolen.
a.What is your total cost of holding cash as a function of the number of days between trips to the ATM? b.How often will you go to the ATM to minimize your costs?
What will be an ideal response?
| a. | The total cost of holding cash = ($1.50 × 365/T) + ($5 ×T / 2 × 0.12) + ($5 ×T / 2 × 0.03) = (547.50 / T) + (0.375 ×T). |
| b. | The total cost is minimized when T = 38. |
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