Arbitrary Profit
Autor: Fu Luo • March 16, 2015 • Coursework • 1,147 Words (5 Pages) • 645 Views
Part A
Based on assumptions given by the assignment, we calculated the percentage profit and loss on initial equity investment for these three scenarios and present following three tables with results.
From Table 1, we can see that if the merger is successfully concluded on 06/28/2005, then the actual percentage profit on equity that arbitrageurs can realize is 12.29%. And the annualized profit on equity is 23.12%.
Table 2 provides the result for scenario that the merger is successfully concluded on 12/31/2005. The results show that the actual percentage profit on equity the arbitrageurs can get is 10.59%, and the annualized profit on equity is 10.17%.
Table 3 presents the results for scenario that the merger offer is withdrawn and canceled on 12/30/2005. The payoff of the long position is -$39,494, and the payoff of the short position is -$13,029. As a result, the actual percentage profit on equity the arbitrageurs can realize is -36.13%. And the annualized profit on equity is -34.79%.
Compare results from scenario one and scenario two, the annualized profit on equity for scenario one is about 2.27 times the annualized profit on equity for scenario two. And the only difference between these two scenarios is that the number of days taken in scenario one is 194, while it is 380 in scenario two. We can conclude that the faster a deal, the higher the return.
And compare gross profit and profit on equity for each scenario, we can see that returns can be enhanced further with leverage.
From scenario three, we can see the potential risks faced by arbitrageurs are really high. High returns always have high risk.
Table 1 Merger successfully concluded on 06/28/2005
Terms of the deal and announcement day closing prices | |
SYMC (AC) to acquire VRTS (TC) in an all stock transaction | |
Initiate Transaction | 12/16/2004 |
Complete Transaction | 06/28/2005 |
Exchange Ratio | 1.1242 AC share for each TC share |
Target (TC) | $26.00 per share closing price on 12/16/2004 |
Acquirer (AC) | $26.80 per share closing price on 12/16/2004 |
Transaction Cost | 0.30% |
Arbitrage Transaction | |
% of transaction on margin | 40% |
% interest charged on margin (annual) | 5% |
Buy TC | 10,000 shares at $26.80 |
AC shares to be received in the exchange | 11,242 |
Short AC | 11,242 shares at $26.00 |
Calculation | |
Cost (purchase TC shares) | $268,000 |
(+) Trans. Cost | $268,804 |
Equity (personal funds) | $160,800 |
Margin (borrowed funds) | $107,200 |
Revenue (short sale of AC shares) | $292,292 |
(-) Trans. Cost | $291,415 |
Net Profit (Net of Transaction Costs) | $22,611 |
Days to complete deal | 194 |
Margin Cost | $2,848.88 |
Net Profit (Net margin and transaction costs) | $19,762 |
% Gross Profit | 7.35% |
% Profit on Equity | 12.29% |
% Profit on equity per day: | 0.06% |
Annualized % profit | 23.12% |
Table 2 Merger successfully concluded on 12/31/2005
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