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Merger arbitrage is the business of stock trading in companies that are known to acquire takeovers or undergo mergers. The process involves buying a stock at a defined price for immediate sale at a higher price.
There is mainly a hedge fund where all the stocks and shares of merging companies are brought and sold simultaneously to ensure a risk-free profit. A merger arbitrageur who takes care of the stock trading often takes advantage of this process because stock prices often come down during the merger. Later on when the merger is complete the prices increases and the arbitrageur always take profit of this thin line discrepancy of stock prices.
It is a fairly simple concept with which the offer and the target price often come into action. During the announcement of the merger, the stocks either decreases slightly or the stock of the acquirer jumps significantly. The jump is mainly based on the offer price that is between two extremes: an all cash offer or a pure stock offer. Merger transactions can gives an option of all cash offer or an all stock offer. In certain cases it can also come up as a combination of the two that also includes the existence of debts and bonds in the process.
In this process of price variation and option selection, merger arbitrage is possible. This is because the stock of the target firm is usually de-listed because of its possibility of not reaching the offer price until the deal is finalized. The best way to conduct a merger arbitrage is to purchase the stock after the announcement of the merger and sell it after the deal finalization when the stock reaches the offer price. |