Risk Arbitrage Abbott Labs and Alza

Risk Arbitrage : Abbott Labs and Alza

1. Green Circle want buy shares of Alza, but not without risk consideration. As written in the endnotes, the size of their exposure to any one (long side) investment doesn’t exceed more than 5% of total fund capital1. From the page 19, we learn that they have collateral requirements for both long and short position of 50%.
Because of their risk policy and their leverage, the position has to be limited to
50%*(5%*500milllion), where the 500 million is the Green Circle’s capital base.
With a position limited to $12.5 million, the maximum number of Alza’s shares they can buy is
12.5mio/48$, i.e 260’416.66 shares. Rounded, they should receive 1.2 Abbot share per Alza share, so they have to sell 260’000*1.2=312’000 shares. That’s why they short 312’000 Abott shares and are long on 260’000 Alza shares.
Assuming each share of alza was bought for : if at the end of the merge, the price of Abbott share is at x $,
Then for each share of Alza owned, we receive 1.2 shares of Abbott, ie in $ :
Expected gain / loss

48
33.5
40.2
-7.8

48
38.5
46.2
-1.8

48
43.5
52.2
4.2

48
48.5
58.2
10.2

48
53.4
64.08
16.08

Assuming each share of abott was sold for : if at the end of the merge, the price of Abbott share is at
Expected gain / loss
And as there is a ratio of 1.2Abbott share per Alza share :
This yield to a gross spread per share of

43.5
33.5
10
12
4.2

43.5
38.5
5
6
4.2

43.5
43.5
0
0
4.2

43.5
48.5
-5
-6
4.2

43.5
53.4
-9.9
-11.88

4.2

As we can see with the table above, with the short position the risk that Green Circle receives less than the spread in case of major price variations before the end of the merge, is deleted.
However, if merging operations are cancelled, then the price of Abbott shares could rise and this one of Alza could decreases ; in such