Question #12
Reading: Reading 34 Hedge Fund Strategies
PDF File: Reading 34 Hedge Fund Strategies.pdf
Page: 4
Status: Incorrect
Correct Answer: A
Your Answer: C
Question
The payoff profile of merger arbitrage positions is similar to the return on:
Answer Choices:
A. a risky bond, short a call and long a put
B. a riskless bond, short a put, and long a call
C. a riskless bond, short a call, and short a put
Explanation
The strategy incorporates the time associated between merger announcement and
transaction closing which is discounted at the risk free rate. M/A hedge funds also earn
additional "premium" from equity holders which reflects the potential that the deal may
not successfully close. Similarly, hedge funds are in effect, long a call if a higher bid were
to surface. All cash flows are discounted at the risk free rate.