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Risk Arbitrage Case

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Risk Arbitrage Case
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 how the arbitrage positions the investment. A major inherent risk of risk arbitrage is the risk that the deal will not be completed and that the position will suffer significant loss.

There are two principal types of mergers, both of which an arbitrageur can take advantage. First, is a cash merger, in which the acquirer proposes to purchase the target firm for a certain price in cash. Typically, the price of the target will trade below the proposed price, so the arbitrageur can buy a long position in the target firm; when the firm is acquired, the stock price will increase and the arbitrageur will profit. The second type of merger is a stock for stock merger, which is the merger being studied in this case. In a stock for stock merger, the acquiring firm proposes to trade its own stock for the stock of the target firm. A typical position in this case is a long-short position in which the arbitrageur places a long position in the target firm and a short position in the acquiring firm; this is known as “setting a spread.” If the merger is completed, the target stock will be converted into the acquirer’s stock based on the exchange ratio that was determined by the merger agreement. The arbitrageur then delivers the converted

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