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

In a stock-for-stock merger, Acquirer offers 0.5 of its shares for each Target share. Acquirer trades at $80 and Target at $38. A merger arbitrageur wants to capture the spread while hedging market exposure to the acquirer's price. Which position is appropriate per 1,000 Target shares?

Buy 1,000 Target shares and short 500 Acquirer shares. The offer is worth 0.5 × $80 = $40 against a $38 price, giving a $2 spread. Shorting at the exchange ratio neutralizes acquirer price moves, leaving the spread as the return.

  1. ALong 1,000 Target shares and short 500 Acquirer shares, with a spread of $2 per Target shareCorrect
  2. BLong 1,000 Target shares and long 500 Acquirer shares
  3. CShort 1,000 Target shares and short 500 Acquirer shares
  4. DLong 1,000 Target shares and short 2,000 Acquirer shares, with a spread of $2 per Target share

Explanation

Offer value is 0.5×80 = $40 versus Target at $38, so the spread is $2. Hedge by shorting 0.5 Acquirer shares per Target share, i.e. 500 shares. Shorting 2,000 inverts the exchange ratio.

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