Merger arbitrage is a type of arbitrage associated with merging entities, for instance two publicly traded businesses.
Broadly speaking, a merger involves two parties: the acquiring company and its target. If the target is a publicly listed company, then the acquiring company needs to purchase the outstanding share of the targeted company. Usually, this is at a premium to what the stock is changing hands for at the time of the announcement, generating a profit for shareholders. As the deal goes public, traders hoping to profit from the agreement purchase the target company’s stock—pushing it closer to the announced deal price.
The target company’s price most times doesn’t reflect the deal price, but, it frequently trades at a slight discount. This is because of the risk that the deal may fail or fall through. Deals can fail for many reasons, including changing market conditions or a refusal of the deal by regulatory bodies.
In its simplest form, merger arbitrage involves an investor purchasing shares of the target company at its discounted price, then profiting when the deal is successful. Yet, there are different forms of merger arbitrage. An investor who thinks a deal might fail or fall through, for instance, might decide to short shares of the target company’s stock.
What Is Merger Arbitrage? Conclusion
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