M&A1 Takeover Arbitrage

A takeover target trades while the chance that the deal closes is updated. Value is weighted by that chance.

Objective

Value TGT as a weighted average: the chance the deal closes times its value if it does, plus the chance it fails times its value if it does. Assessed on profit and loss, with closing positions valued at the final value.

What it shows

• Merger arbitrage: a target trades below the offer because the deal may fail.
• If the deal closes TGT is worth 40; if it fails, 25. The probability of closing is updated three times.
• A price as a weighted average of two outcomes.

Watch out for

• Buying at the deal price as if the deal were certain.
• An update that changes the probability and leaves the price unmoved for a while.
• An outcome drawn at the close: the right view can still lose.

Who takes part

• Trader — every student. Trades TGT, one takeover target, with 100,000 in cash.

Class size

Ten to forty students in one role.