Risk Arbitrage Case

1464 Words Nov 12th, 2012 6 Pages
Risk Arbitrage: Abbott Labs and Alza
Harvard Business Review Case Study

1. BACKGROUND
Risk Arbitrage is essentially just arbitrage with some element of risk. Three main types of risk arbitrage are merger and acquisition arbitrage (also known as just merger arbitrage), liquidation arbitrage, and pairs trading. We will focus on merger arbitrage, as it pertains to this case study. Merger arbitrage is an investment strategy that chooses to capitalize upon arbitrage that presents when a merger or acquisition deal is announced. Essentially, an arbitrageur is seeking to profit from the movements of the acquirer’s and or target’s stock price from the merger. There are two main types of mergers, a cash merger and a stock merger, which determines
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Chris acquired 260,000 shares at $48/share, which came out to a $12.48 million allocation. Since the announced exchange rate was 1.2, Chris also shorted 312,000 shares of Abbott Labs (260,000*1.2=312,000) at $43.50. If the deal did go through, Chris would expect positive returns because the stock price of Alza would increase as a result of the merger (long position would profit) and the stock price of Abbott would decrease as a result of the merger (short position would profit).

Another option Chris could take would be to buy Alza put options maturing December 18th at $3.25 a share for a strike price of $40.00 (Alza’s current share price is $40.12). This could serve to hedge his current position, since if the deal fell through,