Question

Question 60 ABC Corp. has launched a takeover of XYZ Ltd. and is offering a stock swap of 0.65 ABC shares for each XYZ share. After the offer has been announced, ABC shares are trading at $10.00 while XYZ shares are trading at $5.50. A M&A arbitrageur would most likely take what position post announcement (based on the arbitrageur belief that the takeover will take place).

a) Buy 6,500 shares of XYZ and short 10,000 shares of ABC.

b) Buy 10,000 shares of ABC and short 6,500 shares of XYZ.

c) Buy 6,500 shares of ABC and short 10,000 shares of XYZ.

d) Buy 10,000 shares of XYZ and short 6,500 shares of ABC.

e) None of the above.

provide work!

Answer 1

Each share of ABC is worth $10.

Each share of XYZ will receive 0.65 share of ABC then its derived value = $10 × 0.65 = $6.50

But XYZ share is trading at $5.5 (less than for its derived value).

It is better to be long on XYZ shares and short on ABC shares.

Ratio is 0.65

Buy 10,000 shares of XYZ and Short 6,500 shares of ABC.

Net investment = -10,000 × $5.5 + 6,500 × $10 = $10,000 inflow today.

On expiry:

10,000 XYZ shares will convert into 6,500 ABC shares. Long position will adjust with short position will result in $0 outflow.

Arbitrage benefit is $10,000 today.

Answer is:

Buy 10,000 shares of XYZ and short 6,500 shares of ABC.

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