...50.50 45.00 x Number of BT shares received 1.30 1.30 1.30 Value of consideration received 78.00 65.65 58.50 - Basis in MCI stock (62.00) (62.00) (62.00) Gain / (Loss) on Long Position 16.00 3.65 (3.50) Gain / (Loss) on Short Position: Price of BT at time of short sale 50.50 50.50 50.50 - Market value at merger completion 60.00 50.50 45.00 (9.50) 0.00 5.50 x Number of BT shares shorted 1.30 1.30 1.30 Gain / (Loss) on Short Position (12.35) 0.00 7.15 Total Gross Spread at Merger Completion 3.65 3.65 3.65 Source: Note on Risk Arbitrage No matter at what prices the deal closed, merger arbitrageurs are be able to lock-in a risk-free profit. And the only risk of the merger arbitrage is the completion risk. MCI & BT Controversy The two companies were expected to gain the benefit from global communication merger by using each other competency; such as, a large multinational customer base in MCI and the local market expertise in BT. To merge the new global communication company, BT agreed to offer .54 of American Depository Share (ADSs) for each MCI share, plus $6 cash per MCI shares, and also gave a dividend with a total value of $3.6 billion. However, the market and economic condition had been changed, so the original term had to be revised, resulting in less appealing to MCI’s shareholders. The new terms were that each MCI shareholder...
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...Special Report Dexia AM Risk Arbitrage Process February 2010 A Focus on the Kraft / Cadbury deal TRANSACTION HISTORY Kraft approach September 7th - Kraft approached Cadbury Possible hostile offer at 745p per share: 300p cash + 0.2589 KFT Cadbury’s board rejected proposal November 9th - Put up or shut up deadline Kraft Formal Offer November 9th - Formal offer on the initial same terms December 14th - Cadbury published defense document January 2nd - Press rumor: Ferrero, Hersey or Private Equity fund could bid Speculation that Nestlé could be a white knight Potential counter bidders: Hershey January 8th – Kraft sells Pizza Business to Nestle for 3.2bn USD Nestlé said they won’t bid for Cadbury Warren Buffet criticized excess use of Kraft’s shares in Cadbury deal. January 18th – Last day for Kraft to revise offer (in the absence of a counter bid) Kraft Revised Offer January 19th - Kraft increasing bid for Cadbury to 850p per share New deal terms are: 500p + 0.1874 KFT + 10p special Dividend Cadbury’s board has recommended the improved offer January 25th – Ferrero and Hersey said they won’t bid for Cadbury February 2nd – Kraft offer is declared unconditional OUR RECOMMENDATION Set up the risk arbitrage spread at -6% flat Recommended position size 2% for DRA and 4% for DLSRA Fit with diversification of portfolio: high quality deal (top players and high quality assets) Expected return 6% flat / 15% annualized ©Dexia Asset Management - Editorial Date: 02 Mar. 10...
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...32 Number 3 August 2003: 349–380 Long-Term Capital Management and the sociology of arbitrage Donald MacKenzie Abstract Arbitrage is a key process in the practice of financial markets and in their theoretical depiction: it allows markets to be posited as efficient without all investors being assumed to be rational. This article explores the sociology of arbitrage by means of an examination of the arbitrageurs, Long-Term Capital Management (LTCM). LTCM’s 1998 crisis is analysed using both qualitative, interview-based data and quantitative examination of price movements. It is suggested that the roots of the crisis lay in an unstable pattern of imitation that had developed in the markets within which LTCM operated. As the resulting ‘superportfolio’ began to unravel, arbitrageurs other than LTCM fled the market, even as arbitrage opportunities became more attractive, causing huge price movements against LTCM. Three features of the sociology of arbitrage are discussed: its conduct by people often personally known to each other; the possibility and consequences of imitation; and the limits on the capacity of arbitrage to close price discrepancies. It is suggested that by 1998 imitative arbitrage formed a ‘global microstructure’ in the sense of Knorr Cetina and Bruegger. Keywords: arbitrage; economic sociology; imitation; Long-Term Capital Management (LTCM); globalization; risk. Introduction Of all the contested boundaries that define the discipline of sociology...
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...Limits to Arbitrage: Saint Leo University- Chesapeake, Virginia Corporate Finance: MBA 570 Professor Smith April 23, 2014 Abstract Arbitrage is the idea of buying asset which involves no negative cash flow and making a profit with little or no risk. Understanding arbitrage opportunities is not the only ingredient needed to make sharp predictions. The level of irrationality need to be specified by behavior finance researchers. This is related to how they deviate from the Subjective Expected Utility theory. In order to specify the type of irrationality, researchers have turned to experimental evidence complied by cognitive psychologists on the biases that arise when people form beliefs, and on the people’s preferences, given their beliefs or on how they make decisions, Thaler and Barberis (2002). In this paper, we will concentrate on the extensive literature on the Limits to Arbitrage and explain how the theory was conceived, how it evolved over time and apply a scenario to better explain the research. Limits to Arbitrage Understanding arbitrage opportunities is not the only ingredient needed to make sharp predictions. The level of irrationality need to be specified by behavior finance researchers.This is related to how they deviate from the Subjective Expected Utility theory. In order to specify the type of irrationality, researchers have turned to experimental evidence complied by cognitive psychologists on the biases that arise when people form beliefs, and...
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...CHAPTER 10: FUTURES ARBITRAGE STRATEGIES END-OF-CHAPTER QUESTIONS AND PROBLEMS 1. (Delivery Options) The U.S. Treasury bond futures contract contains several imbedded options. First, the wild card option results from a difference in the closing times of the spot and futures markets. The Treasury bond futures contract stops trading at 3:00 P.M. Eastern time. The spot market for Treasury bonds operates until 5:00 P.M. Eastern time. The wild card option is the opportunity the holder of the short futures contract has to lock in the invoice price at 3:00 P.M. and make delivery if the spot price falls below the established invoice price between 3:00 P.M. and 5:00 P.M. The option exists only during the delivery month. Second, the holder of the short position has the right to deliver any of a number of acceptable bonds, known as the quality or switching option. Sometimes the holder of the short position will be holding a bond that is not the best to deliver. A profit is sometimes possible by switching to another bond. Third, because the last day for trading a T-bond futures contract is the eighth-to-last business day of the delivery month and delivery can take place during the remaining business days, there is an end-of-the-month option. The invoice price during those final delivery days is based on the settlement price on the last trading day. Thus, during the last seven delivery days, the holder of the short position has full knowledge of the price that would be received for delivery...
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...American Finance Association Limited Arbitrage in Equity Markets Author(s): Mark Mitchell, Todd Pulvino, Erik Stafford Source: The Journal of Finance, Vol. 57, No. 2 (Apr., 2002), pp. 551-584 Published by: Blackwell Publishing for the American Finance Association Stable URL: http://www.jstor.org/stable/2697750 Accessed: 08/01/2010 15:26 Your use of the JSTOR archive indicates your acceptance of JSTOR's Terms and Conditions of Use, available at http://www.jstor.org/page/info/about/policies/terms.jsp. JSTOR's Terms and Conditions of Use provides, in part, that unless you have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and you may use content in the JSTOR archive only for your personal, non-commercial use. Please contact the publisher regarding any further use of this work. Publisher contact information may be obtained at http://www.jstor.org/action/showPublisher?publisherCode=black. Each copy of any part of a JSTOR transmission must contain the same copyright notice that appears on the screen or printed page of such transmission. JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact support@jstor.org. Blackwell Publishing and American Finance Association...
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...have to pay GBP sterling 1 million in six months. a. What are the advantages and disadvantages of hedging the exchange rate risk with forward contracts, futures contracts and options. (10 marks) b. If the value of the dollar falls rapidly over the next six months relative to GBP sterling, which one of these three would turn out to be better and best, and why? (10 marks) 3. Annualized U.S. and U.K. spot interest rates for a six-month horizon are 4.5% and 5.5% per annum respectively. The spot foreign exchange rate for converting pound sterling to dollars is $2.00 per pound sterling. What will be the forward exchange rate in dollars/pound for a forward contract maturing six months later? (10 marks) 4. Options Trading Strategies a. Explain how a long stock and long put strategy equals the cash flow from a long call strategy. (5 marks) b. Why is a straddle position considered a speculation on the asset’s volatility? (5 marks) c. Can a butterfly spread ever be constructed to have zero initial premium? Why or why not? (5 marks) d. Explain in simple terms why a call option on a non-dividend paying stock should never be exercised early. (5 marks) 5. Consider an index futures arbitrage opportunity. a. What is the effect of dividend uncertainty on the no-arbitrage window and why? (5 marks) b. What is the effect of marking to market cash flows on the no-arbitrage window and why? (5 marks) c. Why and...
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...Risk Arbitrage: Abbott Labs & Alza 1) How does risk arbitrage work? What are the risks and opportunities associated with this strategy? Risk arbitrage, or merger and acquisition arbitrage, is one of three types of arbitrage strategies. Two types of mergers are possible: a cash merger and a stock merger. Cash Merger Opportunities Acquirer proposes to purchase the shares of the target for a certain price in cash. Until the acquisition is completed, the stock of the target usually trades below the purchase price. An arbitrageur buys the stock of the target and makes a gain if the acquirer ultimately buys the stock. Stock-for-Stock Merger Opportunities Acquirer proposes to buy the target by exchanging its own stock for the stock of the target. An arbitrageur my then short sell the acquirer and buy the stock of the target. This is called “setting a spread.” After the merger is completed, the target’s stock will be converted into stock of the acquirer based on the exchange ratio determined by the merger agreement. The arbitrageur delivers the converted stock into his/her short position to complete the arbitrage. Risks Associated with M/A Arbitrage Risks arise from the possibility of deals failing to go through. Obstacles may include either party's inability to satisfy conditions of the merger, a failure to obtain shareholder approval, or failure to receive antitrust and other regulatory clearances. 2) Green circle shorted 312,000 Abbott shares and longed 260,000 Alza...
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...fund. Their collapse was not entirely unforeseeable or unavoidable. Amaranth had amassed very large positions on both the New York Mercantile Exchange (NYMEX) and the Intercontinental Exchange (ICE) in natural gas futures, swaps, and options. The trades consisted mainly of buying and selling natural gas futures contracts with a variety of maturity dates. Their trades were very risky from both a market risk perspective and a liquidity perspective. Background: Amaranth Advisors LLC: Amaranth was a multi-strategy hedge fund headquartered in Greenwich, Connecticut. Nicholas Maounis, a former convertible bond trader, founded Amaranth in September 2000.Amaranth’s initial assets under management of $600 million had grown to between $7.2 billion and $7.5 billion by the end of 2005, which translated to an average annual return of 15%, almost double the average return of other multi-strategy funds over the same period. The Primary strategies employed by the fund included convertible arbitrage, statistical arbitrage, energy trading, merger arbitrage, long/short trading and credit arbitrage. DAAS Capital Advisors: DAAS was a multi-strategy hedge fund, headquartered in the heart of Manhattan. It was founded in 2002 by Ali Armstrong, after he had spent several years as managing director at a major Wall Street investment bank. DAAS had achieved an average annual return of 18.2% since its inception and had grown its assets under management to approximately...
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...For a Sociology of Worth David Stark Columbia University and the Santa Fe Institute Department of Sociology Columbia University 1180 Amsterdam Ave New York, NY 10027 dcs36@columbia.edu Forthcoming in Vando Borghi and Tommaso Vitale, editors, Le convenzioni del lavoro, il lavoro delle convenzioni, numero monografico di Sociologia del Lavoro, n. 102, Milano: Franco Angeli. For a Sociology of Worth David Stark Columbia University and the Santa Fe Institute Parsons’ Pact Arguably, the founding moment of the field of economic sociology took place more than a half-century ago at Harvard, where Talcott Parsons was developing his grand designs for sociology. Parsons’ ambitions were imperial, but there was one field that Parsons maneuvered around instead of claiming outright. That field was hegemonic in his time and is considerably hegemonic still – the discipline of economics. Parsons, therefore, made overt signals to his colleagues in the Economics Department at Harvard alerting them to his ambitious plans and assuring them that he had no designs on their terrain (see Camic 1987). Basically, Parsons made a pact: in my gloss – you, economists, study value; we, the sociologists, will study values. You will have claim on the economy; we will stake our claim on the social relations in which economies are embedded. What have been the effects of Parsons’ Pact? First, by limiting its range, this jurisdictional division of the social sciences placed constraints on sociology...
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...Limited Arbitrage in Equity Markets MARK MITCHELL, TODD PULVINO, and ERIK STAFFORD* ABSTRACT We examine 82 situations where the market value of a company is less than its subsidiary. These situations imply arbitrage opportunities, providing an ideal setting to study the risks and market frictions that prevent arbitrageurs from immediately forcing prices to fundamental values. For 30 percent of the sample, the link between the parent and its subsidiary is severed before the relative value discrepancy is corrected. Furthermore, returns to a specialized arbitrageur would be 50 percent larger if the path to convergence was smooth rather than as observed. Uncertainty about the distribution of returns and characteristics of the risks limits arbitrage. THIS PAPER EXAMINES IMPEDIMENTS to arbitrage in equity markets using a sample of 82 situations between 1985 and 2000, where the market value of a company is less than that of its ownership stake in a publicly traded subsidiary. These situations suggest clear arbitrage opportunities, yet, they often persist, and therefore provide an interesting setting in which to study the risks and market frictions that prevent arbitrageurs from quickly forcing prices to fundamental values. Arbitrage is one of the central tenets of financial economics, enforcing the law of one price and keeping markets efficient. In its purest form, arbitrage requires no capital and is risk free ~see Dybvig and Ross ~1992!!. By simultaneously selling...
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...founder was a Salomon Brothers trader, John Meriwether, and the principal shareholders were Nobel prize-winning economists Myron Scholes and Robert Merton. These were all experts in investing in derivatives to make aboveaverage returns and outperform the market. Investors paid $10 million to get into the fund. They were not allowed to take the money out for three years, or even ask about the types of investments LTCM used. Despite these restrictions, investors clamored to get in, thanks to LTCM's spectacular annual returns of 42.8% in 1995 and 40.8% in 1996. This was after management took 27% off the top in fees. LTCM successfully hedged most of the risk from the 1997 Asian currency crisis, giving its investors a 17.1% return that year. Trading Strategies: LTCM used complex mathematical models to take advantage of fixed income arbitrage deals usually with U.S., Japanese, and European government bonds. Price differences between a 30 year treasury bond and a 29 and three quarter year old Treasury bond is very minimal. However, small discrepancies arise between the two bonds because of a difference in liquidity. By a series of financial transactions, essentially amounting to buying the cheaper 'off-the-run' bond (the 29 and three quarter year old bond) and shorting the more expensive, but more liquid, 'on-the-run' bond (the 30 year bond just issued by the Treasury), it would be...
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...Stock Trak 3 Hedging, speculation, locking in arbitrage profits, liquidity and price discovery are some of the potential uses of futures and forwards. To hedge risk of volatile prices, interest rates and exchange rates. The basic function of the commodity futures market is to transfer risk to someone who is willing to bear it. The speculator assumes the risk because of the potential profit. Hedgers use futures and forwards to reduce the risk that they face from potential future movements in a market variable. Speculators use them to bet on the future direction of a market variable. The futures we invested in were mainly for speculation rather than portfolio insurance. The naked call strategy worked the best for our portfolio. This strategy worked better for us than a covered call because we did not use additional cash to purchase the underlying asset. Our riskiest position was buying puts on Apple and Bidu at the end of the trading period without purchasing a corresponding call option to cover additional losses. Some of the obstacles for investors to beat the market are the volatility of the market, regulations and transaction costs. Some of the most important investment principles investors should adhere to include diversification among asset classes, low transactions costs and rebalancing portfolio assets. In the future, we could concentrate more on long term growth rather than the short term gains. We would also employ more of a buy and hold strategy to...
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...assumed to satisfy the differential equation dBt (1) = rt Bt , dt whose unique solution for the value B0 = 1 is (as the reader will now check) t (2) rs ds . Bt = exp 0 The share price St of the risky asset Stock at time t is assumed to follow a stochastic differential equation (SDE) of the form (3) dSt = µt St dt + σSt dWt , where {Wt }t≥0 is a standard Brownian motion, µt is a nonrandom (but not necessarily constant) function of t, and σ > 0 is a constant called the volatility of the Stock. Proposition 1. If the drift coefficient function µt is bounded, then the SDE (3) has a unique solution with initial condition S0 , and it is given by t (4) St = S0 exp σ Wt − σ 2 (t/2) + µs ds 0 Moreover, under the risk–neutral measure, it must be the case that (5) rt = µt . 1 “The...
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...Investment Management Long Term Capital Management HBS Case Questions 1. Analyze different trading strategies of LTCM Answer: LTCM engaged in primarily in convergence and relative value strategies. Relative value strategy : It is a spread trade and it involves two assets whose prices or yields tend to converge with time . it involves long and short positions of similar instruments. This often happens when a company has more than one holding company listed in different markets (e.g. Royal Dutch and Shell). The price divergence in these different markets creates profitability. Although the price may not completely converge, but the premium tends to narrow over time. Convergence Strategy: In case of convergence strategy the two asset prices or yields must converge. when there was a specifiable future date(usually medium-term fixed maturities) by which convergence of offsetting short and long positions in similar instruments should occur. An example would be a strategy consists of buying off-the-run high yield bonds and shorting on-the-run low yield bonds. Once the newly issued on-the-run bonds become off-the run, the yields on the two bonds converge and LTCM makes a profit. This is a simple strategy and not necessarily a risky trade since it is very likely that the yields will converge once the on-the-run bonds become off-the-run. Since the yield spread between on- and off-the-run bonds is very...
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