Reference no: EM133491836

Question: Merger Arbitrage

Abbott vs Alza (for these questions, use only the information provided in the case, no other source)

Why would you expect positive excess returns from a risk arbitrage strategy? Why wouldn't market efficiency prevent such profits from persisting?

What are the risks and opportunities associated with this strategy?

Assume that the exchange ratio is 1.5 Abbot shares for each Alza share. Assuming the arbitrage position was initiated on June 23, 1999, at the same prices as given in Exhibit 11, page 19 of the case, what is the minimum probability of completion of the merger at which the hedge fund should consider taking a position? Assume the merger is expected to close in 6 months (180 days).

Assume that the exchange ratio is 1.5 Abbot shares for each Alza share. Assuming maximum position size of $12.5m as in Ex 11, how many Alza shares are to be longed and how many Abbott shares are to be sold short in the arbitrage. What can you say about the potential returns and expected returns of the investment, assuming 50% margin on the long (interest rate 4.5%) and short (interest rate 3.5%) positions? Assume the merger is expected to close in 6 months (180 days).

Consider the prices of Abbott and Alza stocks on September 29, 1999 as given on page 8 of the case. As Chris Smith, would you close the position, invest more, or hold on? If you closed the position by reversing the trades at these prices, what is your rate of return?

How could the put option discussed at the end of the case potentially help Smith? Does the put increase or decrease the risk of the position? Does it increase or decrease the expected return? (no calculations necessary, qualitative answer only)