chapter 8 Flashcards
What is the basic strategy behind merger arbitrage?
Buying the target company’s stock and shorting the acquirer’s stock to profit from deal completion.
Why is the spread important in merger arbitrage?
It reflects the potential return if the deal closes and the risk premium investors demand.
What risks are merger arbitrageurs exposed to if the deal fails?
The target’s stock price usually drops sharply, leading to significant losses.
How does the type of merger (cash vs. stock) affect merger arbitrage strategy?
Cash deals focus on target stock; stock deals involve both target and acquirer price movements.
How does a cash transaction create a spread in merger arbitrage?
The target trades at a discount to the offer price until the deal closes.
In a stock-for-stock merger, how do arbitrageurs hedge their position?
By buying the target’s stock and shorting the acquirer’s stock according to the exchange ratio.
What does a widening spread typically indicate about a pending merger?
Increased risk of deal failure or regulatory concerns.
How does deal risk change between friendly and hostile mergers for arbitrageurs?
Hostile mergers typically carry more risk, wider spreads, and less predictability.
What role do regulatory approvals play in merger arbitrage?
Failure to obtain approvals can prevent deal completion, creating arbitrage risk.
Why might arbitrageurs be cautious about mergers involving antitrust reviews?
Because regulatory rejection can cause the target’s stock to collapse.
What are termination fees and how do they impact merger arbitrage strategies?
They compensate the acquirer if the target cancels the deal, slightly reducing downside risk.
How does market sentiment impact merger arbitrage opportunities?
High volatility or uncertainty can widen spreads and increase returns — but also risks.
What is the impact of competing bids on merger arbitrage positions?
They can drive up the target’s stock price but introduce uncertainty about deal completion.
What happens if a merger deal is renegotiated at a lower price?
Arbitrageurs face losses as the expected payout decreases.
Why might arbitrageurs monitor insider trading patterns during a merger announcement?
Unusual insider trading could signal confidence or doubts about the deal closing.
In a stock-for-stock merger facing major antitrust review, what key risks should a merger arbitrageur manage?
Regulatory rejection risk, exchange ratio volatility, and acquirer’s stock price movement.
If a cash merger spread widens significantly after a lawsuit announcement, what does it signal?
Increased deal risk or uncertainty about deal completion.
How would a hostile, stock-for-stock merger impact the arbitrageur’s hedging strategy compared to a friendly cash merger?
Requires managing two correlated positions (long target, short acquirer) with higher volatility and uncertainty.
Why is termination fee information critical in assessing downside risk in merger arbitrage?
Because it provides partial compensation if the deal fails, reducing the magnitude of potential losses.
How could market sentiment shifts after a merger announcement create unexpected losses for arbitrageurs?
Sudden volatility can widen spreads, impact both target and acquirer prices, and introduce new deal risks.
In a stock merger with a fixed exchange ratio, how does a sudden drop in the acquirer’s stock affect the target’s value?
It decreases the effective value offered to the target’s shareholders.
How could competing bids create both an opportunity and a risk for merger arbitrageurs?
Opportunity for higher target price; risk of bidding wars or deal collapse.
Explain why merger arbitrage returns tend to compress as deal certainty increases.
Less perceived risk leads to narrower spreads and lower arbitrage profits.
In a merger arbitrage strategy, what could cause a fully hedged position to still lose money?
Changes in deal terms, failure of the deal, or market movement affecting short/long positions differently.
