Case-Opinion Essay

755 Words4 Pages
Question 1 Ever since the tender offer starts, KKR will place a lot of buy orders to purchase the shares of RJR, which will definitely make RJR stock price increase from its current price. However, based on the Wall Street Journal of Dec 7, 1988, analysts estimated the price of RJR after the successful completion of tender offer will be around $85, which is the intrinsic value of RJR after takeover. As the exhibit 3 shows, there was a huge jump of stock price at October, 1988, which, I believe, was due to the release of the takeover information. Before that, its stock price was around $55, which was its intrinsic value without takeover. So I can make a reasonable assumption that the value of its stock will be $55 if the tender over collapse or $85 if the offer complete successfully. In terms of the arbitrage opportunity, I believe, there is an implicit assumption: the stock you borrow will not be called back until the put option you write is exercised. Otherwise there is a probability you will lose money with your position. I summarize all different outcomes as follow, Profit/Loss | Call back @95+ | Call back @95- | No call back | successful takeover | +0.625 … (1) | +95.625-X … (2) | +10.625 … (3) | tender offer collapse | -29.375 … (4) | +65.625-X … (5) | +10.625 … (6) | The stock price will increase at first, then (1) The takeover is successful, but someone call back the stock at a price above $95 Since someone wants to call back the stock I borrow, so I have to buy a stock right now and give it back to the lender. With a stock price of $95+, I should exercise my call option instead of buying it from the open market, resulting in a cash outflow of $95. If the takeover is successful, the stock price will be $85 in the end and the put option will be exercised, making me lose $10. So my total profit is $105.625-$95-$10, that is, $0.625.
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