Chapter 10 Flashcards
(20 cards)
What is short selling?
Selling a borrowed stock with the hope of buying it back at a lower price.
What are the two main reasons for short selling?
Hedging and speculation.
What is a short squeeze?
A price spike caused by heavy short interest being rapidly bought back.
Why is short selling controversial?
It’s seen as profiting from decline and has been banned during crises in some regions.
How can short selling benefit financial markets?
Short sellers add liquidity, correct overvaluation, and make markets more efficient.
What is merger arbitrage?
Buying target stock post-announcement to profit from the spread between market price and offer price.
Why does a deal spread exist after a merger announcement?
Due to time-to-completion risk and possibility that deal fails.
What actions do arbitrageurs take in a stock-for-stock deal?
Buy target stock and short acquirer stock to lock in spread.
What makes merger arbitrage risky?
Deals can fail due to market, legal, or financing issues. Arbitrage is not riskless.
What is the typical return range on merger arbitrage?
Typically 1–2% annualized return, depending on risk and timing.
What is a cash deal in merger arbitrage?
A straightforward trade where the target gets a fixed cash amount per share.
How is the return calculated in a merger arbitrage cash deal?
Offer price minus current price, adjusted for dividends and commissions.
Why is stock arbitrage harder than cash deal arbitrage?
Stock deals involve volatility, shorting constraints, and uncertain exchange ratios.
What factors affect arbitrage interest in a deal?
Time to close, hostility, regulatory risk, and ease of shorting the acquirer.
How do complex deals complicate arbitrage strategies?
Some deals involve complex securities or investor election options.
What is the role of arbitrageurs in the market?
They provide liquidity to sellers and act as pricing agents.
How do arbitrageurs reduce risk in their portfolios?
By investing in multiple deals to diversify idiosyncratic deal failure risk.
What does the CAPM say about merger arbitrage returns?
Expected return = risk-free rate if markets are efficient, otherwise includes a risk premium.
What explains the acquirer’s stock price drop after an M&A announcement?
Overvaluation signal, reduced growth outlook, and price pressure from short selling.
What is the market efficiency implication of merger arbitrage excess returns?
Large abnormal returns suggest inefficiencies or that arbitrageurs earn a risk premium.
