129:
timeframe originally indicated. The risk arbitrageur must be aware of the risks that threaten both the original terms and the ultimate consummation of the deal. These risks include price cuts, deal extension risk and deal termination. A price cut would lower the offer value of the target's shares, and the arbitrageur could end up with a net loss even if the merger is consummated. An unexpected extension to the deal completion timeframe lowers the expected annualized return which in turn causes a decline in the stock to compensate assuming the probability of the deal completing remains constant. However, the majority of mergers and acquisitions are not revised. Therefore, the arbitrageur need only concern himself with the question of whether the deal will be consummated according to its original terms or terminated. Deal termination can occur for many reasons. These reasons may include either party's inability to satisfy conditions of the merger, a failure to obtain the requisite shareholder approval, failure to receive
112:
holdings if the probability of success improves. The other set of passive arbitrageurs is more involved, but passive nonetheless: these arbitrageurs are more selective with their investments, meticulously testing assumptions on the risk-reward profile of individual deals. This set of arbitrageurs will invest in deals in which they conclude that the probability of success is greater than what the spread implies. Passive arbitrageurs have more freedom in very liquid stocks: the more liquid the target stock, the better risk arbitrageurs can hide their trade. In this case, using the assumption that a higher arbitrageur presence increases the probability of consummation, the share price will not fully reflect the increased probability of success and the risk arbitrageur can buy shares and make a profit. The arbitrageur must decide whether an active role or a passive role in the merger is the more attractive option in a given situation.
66:, the acquirer offers to purchase the shares of the target for a certain price in cash. The target's stock price will most likely increase when the acquirer makes the offer, but the stock price will remain below the offer value. In some cases, the target's stock price will increase to a level above the offer price. This would indicate that investors expect that a higher bid could be coming for the target, either from the acquirer or from a third party. To initiate a position, the arbitrageur will buy the target's stock. The arbitrageur makes a profit when the target's stock price approaches the offer price, which will occur when the likelihood of deal consummation increases. The target's stock price will be equal to the offer price upon deal completion.
99:
merger will consummate increases as arbitrageur control increases. In their study, Cornelli and Li found that the arbitrage industry would hold as much as 30%-40% of a target's stock during the merger process. This represents a significant portion of the shares required to vote yes to deal consummation in most mergers. Thus, takeovers in which arbitrageurs bought shares had an actual success rate higher than the average probability of success implied by market prices. As a result, they can generate substantial positive returns on their portfolio positions.
141:. A collar occurs in a stock-for-stock merger, where the exchange ratio is not constant but changes with the price of the acquirer. Arbitrageurs use options-based models to value deals with collars. 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.
967:
957:
947:
977:
654:
168:
profitability of merger arbitrage in
Australia using a sample of 193 bids from January 1991 to April 2000; the portfolio returned 0.84% to 1.20% per month. Mitchell and Pulvino used a sample of 4,750 offers between 1963 and 1998 to characterize the risk and return in risk arbitrage; the portfolio generated annualized returns of 6.2%.
188:
In this case, the arbitrageur can purchase shares of
Company A's stock for $ 70. He will gain $ 10 if the deal is completed and lose $ 30 if the deal is terminated (assuming the stock returns to its original $ 40 in a break, which may not occur). According to the market, the probability that the deal
98:
and Li contend that arbitrageurs are actually the most important element in determining the success of a merger. Since arbitrageurs have made significant financial bets that the merger will go through, it is expected that they will push for consummation. For this very reason, the probability that the
111:
initiate sales processes or hold back support from ongoing mergers in attempts to solicit a higher bid. On the other end of the spectrum, passive arbitrageurs do not influence the outcome of the merger. One set of passive arbitrageurs invests in deals that the market expects to succeed and increases
196:
Short sell
Company A's stock at $ 70. They would do this if he believes the probability that the deal will be terminated is higher than the odds offered by the market. If the arbitrageur believes the probability the deal will be occur is greater than 50% (that is, they believe the acquisition will
77:
the acquirer's stock. This process is called "setting a spread". The size of the spread positively correlates to the perceived risk that the deal will not be consummated at its original terms. The arbitrageur makes a profit when the spread narrows, which occurs when deal consummation appears more
78:
likely. Upon deal completion, the target's stock will be converted into stock of the acquirer based on the exchange ratio determined by the merger agreement. At this point in time, the spread will close. The arbitrageur delivers the converted stock into his short position to close his position.
167:
In the long run, risk arbitrage appears to generate positive returns. Baker and
Savasoglu replicated a diversified risk arbitrage portfolio containing 1,901 mergers between 1981 and 1996; the portfolio generated excess annualized returns of 9.6%. Maheswaran and Yeoh examined the risk-adjusted
128:
Risk "arbitrage" is not risk-free. Its profits materialize if the spread, which exists as a result of the risk that the merger will not be consummated at its original terms, eventually narrows. Risk arises from the possibility of deals failing to go through or not being consummated within the
153:
Several authors find that the returns to risk arbitrage are somewhat uncorrelated to the returns of the stock market in typical market environments. However, risk arbitrage is not necessarily insensitive to the performance of the stock market in all market conditions. When the stock market
171:
The arbitrageur can face significant losses when a deal does not go through. Individual deal spreads can widen to more than fifty percent in broken deals. The HFRI Merger
Arbitrage Index posted a maximum one-month loss of -6.5% but a maximum one-month gain of only 2.9% from 1990 to 2005.
184:
Suppose
Company A is trading at $ 40 a share. Then Company X announces a plan to buy Company A, in which case holders of Company A's stock get $ 80 in cash. Then Company A's stock jumps to $ 70. It does not go to $ 80 since there is some chance the deal will not go through.
144:
A 2010 study of 2,182 mergers between 1990 and 2007 experienced a break rate of 8.0%. A study conducted by Baker and
Savasoglu, which replicated a diversified risk arbitrage portfolio containing 1,901 mergers between 1981 and 1996, experienced a break rate of 22.7%.
197:
still occur) but less than the probability assigned by the market (say, 60% in this example), they must also assume that the market will assign a probability of deal occurrence closer to their belief at some point before the close of the acquisition.
158:
between merger arbitrage returns and risk arbitrage returns can increase to 0.5. This suggests that the exposure to market risk is asymmetric: the arbitrageur does not participate in market rallies, but tends to suffer losses in downturns.
59:, one company, the acquirer, makes an offer to purchase the shares of another company, the target. As compensation, the target will receive cash at a specified price, the acquirer's stock at specified ratio, or a combination of the two.
175:
Merger arbitrage is significantly constrained by transaction costs. Arbitrageurs could generate abnormally high returns using this strategy, but the frequency and high cost of trades negate much of the profits.
133:
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.
73:, the acquirer offers to purchase the target by exchanging its own stock for the target's stock at a specified ratio. To initiate a position, the arbitrageur will buy the target's stock and
425:
120:
The risk-return profile in risk arbitrage is relatively asymmetric. There is typically a far greater downside if the deal breaks than there is upside if the deal is completed.
193:
Purchase
Company A's stock at $ 70. They would do this if he believes the probability that the deal will close is higher than or in-line with the odds offered by the market.
107:
The arbitrageur can generate returns either actively or passively. Active arbitrageurs purchase enough stock in the target to control the outcome of the merger. These
223:
382:
950:
363:
251:
189:
is consummated at its original terms is 75% and the probability that the deal will be terminated is 25%. The arbitrageur has three choices:
927:
831:
531:
473:
344:
970:
805:
793:
70:
63:
1006:
504:
326:
86:
Baker and
Savasoglu contend that the best single predictor of merger success is hostility: only 38% of
932:
876:
595:
522:
466:
769:
639:
35:
871:
779:
774:
738:
635:
599:
38:. An investor that employs this strategy is known as an arbitrageur. Risk arbitrage is a type of
881:
678:
551:
527:
512:
306:
39:
445:
906:
564:
536:
517:
1011:
960:
811:
723:
559:
541:
459:
278:
108:
8:
980:
886:
866:
693:
668:
27:
405:
1001:
891:
836:
748:
302:
95:
91:
614:
590:
574:
87:
783:
718:
138:
42:
in that it attempts to exploit pricing inefficiencies caused by a corporate event.
922:
826:
816:
797:
764:
688:
683:
619:
604:
137:
Additional complications can arise on a deal-by-deal basis. An example includes
821:
801:
155:
995:
896:
861:
787:
74:
901:
856:
743:
728:
609:
733:
673:
31:
482:
499:
327:"Determinants and implications of arbitrage holdings in acquisitions"
130:
653:
406:"The Profitability of Merger Arbitrage: Some Australian Evidence"
383:"The Shrinking Merger Arbitrage Spread: Reasons and Implications"
56:
451:
224:"Hedge Fund Merger Arbitrage Strategy | Hedge Fund Education"
426:"Characteristics of Risk and Return in Risk Arbitrage"
200:
Do not get involved in the deal at this point in time.
90:
deals were successfully consummated, while so-called
102:
345:"Hidden Risk In Merger Arbitrage - Deal Extension"
993:
279:"Limited arbitrage in mergers and acquisitions"
81:
218:
216:
214:
467:
399:
397:
395:
951:Alternative investment management companies
928:Standards Board for Alternative Investments
423:
419:
417:
415:
211:
976:
832:Taxation of private equity and hedge funds
474:
460:
403:
361:
297:
295:
293:
291:
276:
154:experiences a decrease of 4% or more, the
392:
324:
245:
243:
241:
239:
237:
412:
404:Maheswaran, Krishnan; Yeoh, Soon Chin.
320:
318:
316:
288:
272:
270:
268:
266:
264:
994:
355:
301:
234:
115:
532:fixed-income relative-value investing
455:
374:
342:
94:deals boasted a success rate of 82%.
380:
313:
261:
277:Baker, Malcolm; Savasoglu, Serkan.
249:
123:
13:
252:"Merger (Risk) Arbitrage Strategy"
14:
1023:
439:
103:Active vs. passive risk arbitrage
975:
966:
965:
956:
955:
946:
945:
652:
362:Karolyi, Andrew; Shannon, John.
34:on the successful completion of
481:
424:Mitchell, Mark; Pulvino, Todd.
343:Spink, Mal (6 December 2018).
336:
148:
1:
325:Hsieh, Jim; Walkling, Ralph.
307:"Risk Arbitrage in Takeovers"
204:
806:security characteristic line
364:"Canadian Investment Review"
82:Predictors of merger success
7:
794:Capital asset pricing model
513:Capital structure arbitrage
381:Jetley, Gaurav; Xi, Xinyu.
10:
1028:
596:Commodity trading advisors
349:mergerarbitragelimited.com
179:
162:
50:
941:
933:Managed Funds Association
915:
877:High-net-worth individual
849:
757:
711:
702:
661:
650:
628:
583:
550:
498:
489:
45:
770:Arbitrage pricing theory
368:www.investmentreview.com
36:mergers and acquisitions
882:Institutional investors
775:Assets under management
600:managed futures account
907:Sovereign wealth funds
679:High-frequency trading
528:Fixed income arbitrage
40:event-driven investing
749:Structured securities
565:Distressed securities
537:Statistical arbitrage
523:Equity market neutral
518:Convertible arbitrage
867:Financial endowments
812:Fundamental analysis
560:Shareholder activism
542:Volatility arbitrage
228:www.barclayhedge.com
981:List of hedge funds
971:Hedge fund managers
887:Insurance companies
872:Fund of hedge funds
780:Black–Scholes model
694:Proprietary trading
669:Algorithmic trading
636:Fund of hedge funds
448:- Risk Encyclopedia
303:Cornelli, Francesca
116:Risk-return profile
28:investment strategy
16:Investment strategy
837:Technical analysis
250:Demeter, Michael.
109:activist investors
1007:Financial markets
989:
988:
845:
844:
648:
647:
615:Long/short equity
591:Convergence trade
575:Special situation
1019:
979:
978:
969:
968:
959:
958:
949:
948:
892:Investment banks
739:Foreign exchange
709:
708:
656:
496:
495:
476:
469:
462:
453:
452:
433:
432:
430:
421:
410:
409:
401:
390:
389:
387:
378:
372:
371:
359:
353:
352:
340:
334:
333:
331:
322:
311:
310:
299:
286:
285:
283:
274:
259:
258:
256:
247:
232:
231:
220:
124:Deal-level risks
24:merger arbitrage
22:, also known as
1027:
1026:
1022:
1021:
1020:
1018:
1017:
1016:
992:
991:
990:
985:
937:
923:Fund governance
911:
841:
765:Absolute return
753:
704:
698:
689:Program trading
684:Prime brokerage
657:
644:
624:
620:Trend following
605:Dedicated short
579:
546:
503:
491:
485:
480:
442:
437:
436:
428:
422:
413:
402:
393:
385:
379:
375:
360:
356:
341:
337:
329:
323:
314:
300:
289:
281:
275:
262:
254:
248:
235:
222:
221:
212:
207:
182:
165:
151:
126:
118:
105:
84:
53:
48:
17:
12:
11:
5:
1025:
1015:
1014:
1009:
1004:
987:
986:
984:
983:
973:
963:
953:
942:
939:
938:
936:
935:
930:
925:
919:
917:
913:
912:
910:
909:
904:
899:
897:Merchant banks
894:
889:
884:
879:
874:
869:
864:
862:Family offices
859:
853:
851:
847:
846:
843:
842:
840:
839:
834:
829:
824:
822:Securitization
819:
814:
809:
791:
777:
772:
767:
761:
759:
755:
754:
752:
751:
746:
741:
736:
731:
726:
721:
715:
713:
706:
700:
699:
697:
696:
691:
686:
681:
676:
671:
665:
663:
659:
658:
651:
649:
646:
645:
643:
642:
632:
630:
626:
625:
623:
622:
617:
612:
607:
602:
593:
587:
585:
581:
580:
578:
577:
572:
570:Risk arbitrage
567:
562:
556:
554:
548:
547:
545:
544:
539:
534:
525:
520:
515:
509:
507:
505:relative value
493:
487:
486:
479:
478:
471:
464:
456:
450:
449:
446:Risk Arbitrage
441:
440:External links
438:
435:
434:
411:
391:
373:
354:
335:
312:
287:
260:
233:
209:
208:
206:
203:
202:
201:
198:
194:
181:
178:
164:
161:
156:beta (finance)
150:
147:
125:
122:
117:
114:
104:
101:
83:
80:
52:
49:
47:
44:
20:Risk arbitrage
15:
9:
6:
4:
3:
2:
1024:
1013:
1010:
1008:
1005:
1003:
1000:
999:
997:
982:
974:
972:
964:
962:
954:
952:
944:
943:
940:
934:
931:
929:
926:
924:
921:
920:
918:
914:
908:
905:
903:
902:Pension funds
900:
898:
895:
893:
890:
888:
885:
883:
880:
878:
875:
873:
870:
868:
865:
863:
860:
858:
857:Vulture funds
855:
854:
852:
848:
838:
835:
833:
830:
828:
825:
823:
820:
818:
815:
813:
810:
807:
803:
799:
795:
792:
789:
788:delta neutral
785:
781:
778:
776:
773:
771:
768:
766:
763:
762:
760:
756:
750:
747:
745:
744:Money markets
742:
740:
737:
735:
732:
730:
727:
725:
722:
720:
717:
716:
714:
710:
707:
701:
695:
692:
690:
687:
685:
682:
680:
677:
675:
672:
670:
667:
666:
664:
660:
655:
641:
640:Multi-manager
637:
634:
633:
631:
627:
621:
618:
616:
613:
611:
608:
606:
603:
601:
597:
594:
592:
589:
588:
586:
582:
576:
573:
571:
568:
566:
563:
561:
558:
557:
555:
553:
549:
543:
540:
538:
535:
533:
529:
526:
524:
521:
519:
516:
514:
511:
510:
508:
506:
501:
497:
494:
488:
484:
477:
472:
470:
465:
463:
458:
457:
454:
447:
444:
443:
427:
420:
418:
416:
407:
400:
398:
396:
384:
377:
369:
365:
358:
350:
346:
339:
328:
321:
319:
317:
308:
305:; Li, David.
304:
298:
296:
294:
292:
280:
273:
271:
269:
267:
265:
253:
246:
244:
242:
240:
238:
229:
225:
219:
217:
215:
210:
199:
195:
192:
191:
190:
186:
177:
173:
169:
160:
157:
146:
142:
140:
135:
132:
121:
113:
110:
100:
97:
93:
89:
79:
76:
72:
67:
65:
60:
58:
43:
41:
37:
33:
29:
25:
21:
734:Fixed income
610:Global macro
569:
552:Event-driven
376:
367:
357:
348:
338:
227:
187:
183:
174:
170:
166:
152:
143:
136:
127:
119:
106:
85:
71:stock merger
68:
61:
54:
23:
19:
18:
1012:Hedge funds
961:Hedge funds
724:Derivatives
719:Commodities
674:Day trading
584:Directional
483:Hedge funds
149:Market risk
64:cash merger
996:Categories
916:Governance
490:Investment
205:References
75:short sell
32:speculates
1002:Arbitrage
850:Investors
500:Arbitrage
131:antitrust
492:strategy
96:Cornelli
92:friendly
26:, is an
712:Markets
703:Related
662:Trading
180:Example
163:Returns
139:collars
88:hostile
51:Mergers
784:Greeks
729:Equity
57:merger
46:Basics
827:Short
817:Hedge
798:alpha
705:terms
629:Other
429:(PDF)
386:(PDF)
330:(PDF)
282:(PDF)
255:(PDF)
69:In a
62:In a
55:In a
30:that
802:beta
758:Misc
998::
804:/
800:/
786::
638:/
598:/
530:/
414:^
394:^
366:.
347:.
315:^
290:^
263:^
236:^
226:.
213:^
808:)
796:(
790:)
782:(
502:/
475:e
468:t
461:v
431:.
408:.
388:.
370:.
351:.
332:.
309:.
284:.
257:.
230:.
Text is available under the Creative Commons Attribution-ShareAlike License. Additional terms may apply.