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View Full Version : Is the difference very big ? FMKT


bigpooch
01-27-2004, 11:06 AM
Why such a big difference?

2.25 x ARBA + $2.00 = 2.25 x $3.49 + $2.00 = $9.8525

but FMKT = $9.64 < $9.85

Maybe the risk premium is too high.

adios
01-27-2004, 12:16 PM
To be honest it doesn't seem like much of a spread. For grins how would you "arbitrage it" to capture the spread?

mosta
01-27-2004, 03:46 PM
I'm not sure exactly what you're asking and don't mean to tell you what you know, but: takeover stocks generally trade under the takeout price due to the possibility that the deal will fall through at some point (typically, regulatory approval and shareholder vote). In fact you can take the spread, discount it, and calculate a "percent chance" that the deal will hold up. Betting that the deal will go through is risk arbitrage. You can be assured that there are many big players constantly watching the exact size of the spread and trading it actively. If you want to get in the game, go for it and good luck. PS/BTW there are some deals where the target stock trades above the takeover price because the deal is one that will normally involve some extra juice at the back end, as good will. I don't know when and why this happens or doesn't happen, but TYC reacquring CIT was one example.

mosta
01-27-2004, 06:33 PM
also, to state the obvious just in case: if you wanted to bet that the deal will go through you would buy the target stock and short the acquiring stock, to capture the spread between the target price at that moment and the actual price trading, beneath that. to use your numbers: sell ARBA short at 3.49, buy FMKT for 9.64. do it on the ratio of the share exchange--ie, short 2.25 shares of ARBA for every share of FMKT that you buy (obviously you'd have to round unless you buy at least 100 shares of FMKT). Now when the deal goes through, your FMKT stock will turn into ARBA stock (+ cash), which closes your ARBA short, leaving you with no stock position either way. And I won't go through all the arithmetic, but you will be left with that .21 cent spread as your profit.

You compare that return minus the cost of carrying the position to the risk free rate and you infer a probability for the deal. (I think this is how you do it--I'm not a risk arb'er.) If the return is double the risk free rate then that means the market is giving the deal a 50% chance of going through.