How to Manage Merger Arbitrage Risk

(Daily Alts) In this video, Steve Gerbel explains merger arbitrage by making an analogy to air travel: “They say the safest place for an airplane is in the hangar, but that’s not what airplanes are for,” he says. When we fly, we want the reward of air travel, and we’re willing to take on some risk in pursuit of that reward – but we want the risk to be as minimal as possible. This, according to hedge-fund expert Mr. Gerbel, is what the SilverPepper Merger Arbitrage Fund does: it seeks the highest rewards for the least risk.

What is merger-arbitrage? Mr. Gerbel explains with an example of a stock trading at $8.50. When another firm announces its intention to acquire it at $10 per share, the share price of the acquisition target might rise to $9.70 – the remaining $0.30 reflects the uncertainty that the deal might not go through, and this is where arbitrage comes in. By buying shares of the acquisition target after the announcement but before the deal is closed, SilverPepper seeks to make a predictable $0.30 gain on the deal. “Dime after dime,” this adds up.

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