Information about Risk Arbitrage
Risk arbitrage, or merger arbitrage, is an investment or trading strategy often associated with hedge funds.
Two principal types of merger are possible:
In a cash merger, an acquirer proposes to purchase the shares of the target for a certain price in cash. Until the acquisition is completed, the stock of the target typically trades below the purchase price. An arbitrageur buys the stock of the target and makes a gain if the acquirer ultimately buys the stock.
In a stock for stock merger , the acquirer proposes to buy the target by exchanging its own stock for the stock of the target. An arbitrageur may then short sell the acquirer and buy the stock of the target. This process is called "setting a spread". After the merger is completed, the target's stock will be converted into stock of the acquirer based on the exchange ratio determined by the merger agreement. The arbitrageur delivers the converted stock into his short position to complete the arbitrage.
If that were all there was to it, then everyone would do it immediately, and any possible gain would disappear very quickly. But there is always a risk that the deal will not go through or the closing will be delayed. Obstacles may include either party's inability to satisfy conditions of the merger, a failure to obtain the requisite shareholder approval, failure to receive antitrust and other regulatory clearances, or some other event which may change the target's or the acquirer's willingness to consummate the transaction. Such possibilities put the risk in the term risk arbitrage.
Additional complications can arise in stock for stock mergers when the exchange ratio is not constant but changes with the price of the acquirer. These are called "collars" and arbitrageurs use options-based models to value deals with collars. In addition, the exchange ratio is commonly determined by taking the average of the acquirer's closing price over a period of time (typically 10 trading days prior to close), during which time the arbitrageur would actively hedge his position in order to ensure the correct hedge ratio.
In terms of hedge fund strategies, risk arbitrage shares some properties with other forms of arbitrage such as relative value, volatility arbitrage, convertible arbitrage, and statistical arbitrage, but it is also an example of an event driven strategy.
Two principal types of merger are possible:
In a cash merger, an acquirer proposes to purchase the shares of the target for a certain price in cash. Until the acquisition is completed, the stock of the target typically trades below the purchase price. An arbitrageur buys the stock of the target and makes a gain if the acquirer ultimately buys the stock.
In a stock for stock merger , the acquirer proposes to buy the target by exchanging its own stock for the stock of the target. An arbitrageur may then short sell the acquirer and buy the stock of the target. This process is called "setting a spread". After the merger is completed, the target's stock will be converted into stock of the acquirer based on the exchange ratio determined by the merger agreement. The arbitrageur delivers the converted stock into his short position to complete the arbitrage.
If that were all there was to it, then everyone would do it immediately, and any possible gain would disappear very quickly. But there is always a risk that the deal will not go through or the closing will be delayed. Obstacles may include either party's inability to satisfy conditions of the merger, a failure to obtain the requisite shareholder approval, failure to receive antitrust and other regulatory clearances, or some other event which may change the target's or the acquirer's willingness to consummate the transaction. Such possibilities put the risk in the term risk arbitrage.
Additional complications can arise in stock for stock mergers when the exchange ratio is not constant but changes with the price of the acquirer. These are called "collars" and arbitrageurs use options-based models to value deals with collars. In addition, the exchange ratio is commonly determined by taking the average of the acquirer's closing price over a period of time (typically 10 trading days prior to close), during which time the arbitrageur would actively hedge his position in order to ensure the correct hedge ratio.
In terms of hedge fund strategies, risk arbitrage shares some properties with other forms of arbitrage such as relative value, volatility arbitrage, convertible arbitrage, and statistical arbitrage, but it is also an example of an event driven strategy.
External links
- ArbitrageView.com - Risk arbitrage opportunities in pending merger deals in the U.S. market
In economics and finance, arbitrage is the practice of taking advantage of a price differential between two or more markets: a combination of matching deals are struck that capitalize upon the imbalance, the profit being the difference between the market prices.
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Investment or investing[1] is a term with several closely-related meanings in business management, finance and economics, related to saving or deferring consumption.
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A hedge fund is an investment fund structured to avoid direct regulation and taxation in major host countries and which charges a performance fee based on the increase of the value of the fund's assets.
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mergers and acquisitions (abbreviated M&A) refers to the aspect of corporate strategy, corporate finance and management dealing with the buying, selling and combining of different companies that can aid, finance, or help a growing company in a given industry grow rapidly
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In finance, short selling or "shorting" is a way to profit from the decline in price of a security, such as a stock or a bond. In contrast, investors who "go long" with an investment hope the price will rise.
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United States
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- Sherman Antitrust Act
- Clayton Antitrust Act
- Robinson-Patman Act
- Federal Trade Commission Act
- Essential facilities doctrine
- Noerr-Pennington doctrine
- Rule of reason
- European Community
competition law
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In economics and finance, arbitrage is the practice of taking advantage of a price differential between two or more markets: a combination of matching deals are struck that capitalize upon the imbalance, the profit being the difference between the market prices.
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Volatility arbitrage (or vol arb) is a type of statistical arbitrage that is implemented by trading a delta neutral portfolio of an option and its underlier. The objective is to take advantage of differences between the implied volatility of the option, and a forecast of future
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Convertible arbitrage is a market neutral investment strategy often associated with hedge funds. It involves the simultaneous purchase of convertible securities and the short sale of the same issuer's common stock.
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Statistical arbitrage, or StatArb, as opposed to (deterministic) arbitrage, is related to the statistical mispricing of one or more assets based on the expected value of these assets. For example, consider a game in which one flips a coin and collects $1 on heads or pays $0.
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