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

In a stock-for-stock merger, Acquirer A will exchange 0.5 shares of A for each share of Target T. A merger arbitrage fund wishes to capture the deal spread while limiting exposure to the acquirer's market price movement. What is the standard position?

The fund should buy the target and short 0.5 shares of the acquirer per target share. The short hedges the value of acquirer shares that will be received at closing, leaving the fund exposed mainly to the spread and deal completion risk rather than the acquirer's price.

  1. ABuy T and sell short 0.5 shares of A for each share of TCorrect
  2. BBuy T and buy 0.5 shares of A for each share of T
  3. CSell short T and sell short 0.5 shares of A for each share of T
  4. DSell short T and buy 2 shares of A for each share of T

Explanation

The fund buys the target and shorts the acquirer at the exchange ratio, so the position hedges the value of the shares to be received. If A falls, the loss on T is offset by the gain on the short. Buying both doubles the exposure to A.

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