Risk Arbitrage

Chapter 3

Merger Arbitrage:Practical Applications

Chapter 2 provided an analytical background for merger arbitrage. In this chapter we test the usefulness of this approach by applying it to various merger arbitrage situations that occurred first during the pre-1971 period of the first edition of Risk Arbitrage and then to subsequent and more recent merger situations. In each case the author will explain how he has arrived at the parity and then follow through to see what the actual return (or loss) on capital would have been if positions had actually been taken at the quoted prices.

Mergers Prior to 1971

In this section we will go through a “how to” exercise in calculating the return on investment for the arbitrageur who was in the employ of a New York Stock Exchange member firm in the pre-1971 era, and then go to a calculation of return for a private or institutional investor who was subject to much greater capital requirements. The returns will be figured on a net basis disregarding income taxes and transfer taxes.

Generic Calculation of Co. B. Being Acquired by Co. A (Co. B/Co. A)

As our example, let us assume that Company A, whose common stock is trading at $50, will offer one of its common for each common of Company B, trading currently at $45. Let us further assume that the 90-day Treasury Bill yield, or the “call” rate, is 7 percent, and that A and B will have a dividend record date prior to the consummation of the merger, with A paying a dividend of $0.50 ...