Merger arbitrage

Merger arbitrage is an investment strategy that aims to generate profits from successfully completed mergers and/or takeovers.

It is one of the arbitrage strategies that investors use to earn returns that far surpass their initial investments. In this case, merger arbitrage is an event-driven investment strategy, whereby investors buy the stock of a company before the merger takes place in hopes that the merger would result in a higher market capitalization than before. 

The risk associated with this particular strategy relies on the deal not going through, because investors interested in merger arbitrage are buying the respective shares long before the official settlement of the merger – particularly to reap larger profits. 

In situations of an arbitrage merger, people commonly refer to the arbitrage spread. The arbitrage spread represents the difference between the acquisition price of the shares as paid by the acquiring company and the market price of the shares paid by the investor. The larger the spread, the higher the potential reward for the investor.

Commonly, it is possible to distinguish between two kinds of merger arbitrage:

• Active arbitrage – implies that the owner of the shares has enough of them to exercise influence over the outcome of the merger
• Passive arbitrage – implies that the owner of the shares doesn’t hold enough shares to influence the deal.