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Abbott Labs

In: Business and Management

Submitted By phillyb
Words 1110
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Risk Arbitrage: Abbott Labs & Alza

1) How does risk arbitrage work? What are the risks and opportunities associated with this strategy?

Risk arbitrage, or merger and acquisition arbitrage, is one of three types of arbitrage strategies. Two types of mergers are possible: a cash merger and a stock merger.
Cash Merger Opportunities
Acquirer proposes to purchase the shares of the target for a certain price in cash. Until the acquisition is completed, the stock of the target usually trades below the purchase price. An arbitrageur buys the stock of the target and makes a gain if the acquirer ultimately buys the stock.
Stock-for-Stock Merger Opportunities
Acquirer proposes to buy the target by exchanging its own stock for the stock of the target. An arbitrageur my then short sell the acquirer and buy the stock of the target. This is called “setting a spread.” After the merger is completed, the target’s stock will be converted into stock of the acquirer based on the exchange ratio determined by the merger agreement. The arbitrageur delivers the converted stock into his/her short position to complete the arbitrage.
Risks Associated with M/A Arbitrage
Risks arise from the possibility of deals failing to go through. Obstacles may include either party's inability to satisfy conditions of the merger, a failure to obtain shareholder approval, or failure to receive antitrust and other regulatory clearances.

2) Green circle shorted 312,000 Abbott shares and longed 260,000 Alza shares in the investment. How did they determine the appropriate relative position sizes? What can you say about the potential returns and expected returns from the investment?

Relative Position Sizes
In order to avoid concentration risk, Green Circle limited the size of its exposure to any one investment so that the long position exceeded no more than 5% of total fund capital ($500M)....

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