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

A merger arbitrage fund holds a long position in a target in a stock-for-stock deal in which each target share will be exchanged for 0.5 shares of the acquirer. Which hedge best isolates the deal-spread risk?

The fund should short 0.5 acquirer shares for each target share held, matching the exchange ratio. This offsets acquirer price movements, leaving the position exposed mainly to the deal spread and the risk of deal failure rather than to market moves in the acquirer's stock.

  1. AShort 0.5 acquirer shares per target share heldCorrect
  2. BShort 2 acquirer shares per target share held
  3. CShort 1 acquirer share per target share held
  4. DHold no hedge, since the exchange ratio fixes the value

Explanation

Each target share converts into 0.5 acquirer shares, so shorting 0.5 acquirer shares per target share offsets exposure to the acquirer's price. Shorting 2 or 1 over-hedges. No hedge leaves the fund exposed to acquirer price moves because the deal value floats.

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