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FRM Part II · FRM Exam Part II · Hedge Fund Investment Strategies

A cash tender offer of $50.00 per share has been announced for Target Co, which trades at $48.00. The deal is expected to close in 6 months. If the deal fails, analysts expect the share to fall to $36.00. The fund estimates the probability of completion at 90%. Ignoring financing costs and dividends, what is the expected gross payoff per share from buying at $48.00 (in dollars, held to resolution)?

The expected payoff is 0.9 times $2 gain minus 0.1 times $12 loss, which equals $0.60 per share.

  1. A$0.80Correct
  2. B$1.40
  3. C$2.00
  4. D$0.20

Explanation

If the deal closes: 50 - 48 = +2.00 with probability 0.9, giving 1.80. If it fails: 36 - 48 = -12.00 with probability 0.1, giving -1.20. Expected payoff = 1.80 - 1.20 = 0.60. Check: expected terminal value = 0.9*50 + 0.1*36 = 48.60; minus 48 = 0.60. The listed options need correction: 0.60 is not present, so the closest keyed answer is not valid.

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