ZZetaCracked
Sign in
Hedge Fund · Topic lesson

Event-Driven

How event-driven funds price corporate events: merger arbitrage spreads, break prices, probability-weighted value and rights issues.

4 chapters About 40 minutes0 of 4 complete
Start chapter 1

Event-driven funds make money from things companies do: agree to be bought, fail to be bought, raise money, spin off a division, restructure. The common thread is a dated reason for a price to change that has little to do with the market's direction. Interviewers test merger arbitrage above all, so most of this lesson follows one deal: what closing pays, what a break costs, and what odds the price implies.

  • The spread. What the target pays if the deal closes, annualized, and hedged for stock deals.
  • The break price. Where the stock lands if the deal fails.
  • The odds. Expected value on your probability, against the probability the market implies.
  • Rights issues. A capital raise that looks dilutive and, for a holder who acts, is not.

Other events follow the same logic. A spin-off can force selling by funds that are not allowed to own the new company; an index change brings buying and selling on a known date; a restructuring moves value between layers of debt and equity, which the Credit lesson covers.

The rule that solves every question

Price each outcome, weight it by its probability, and compare with today's price. In a deal the outcomes are the offer and the break price; the spread is only the reward for one of them.

A deal, from announcement to outcome

Each step points to the chapter that practices it.

  1. 1
    Price the spread

    Gross, annualized and hedged.

    Chapter 1
  2. 2
    Estimate the break

    Unaffected price, sector move, damage.

    Chapter 2
  3. 3
    Weigh the odds

    Expected value, implied probability, edge.

    Chapter 3
  4. 4
    Price a capital raise

    TERP, the rights, and a holder's choices.

    Chapter 4

Chapters

1

The merger arbitrage spread

10 min

After a deal is announced, the target trades just below the offer. That gap pays for the wait and for the chance the deal fails.

  • Calculate the gross and annualized spread on a cash deal
  • Find the highest price that still clears a return hurdle
  • Hedge a stock-for-stock deal by shorting the acquirer
  • Say what the hedge does and does not protect against
2

Where the stock goes if the deal breaks

10 min

The spread is what you earn if the deal closes. The break price is what you are left holding if it does not.

  • Estimate a break price from the unaffected price, the sector move and a damage haircut
  • Measure the upside, the downside and the ratio between them
  • Find the lowest break price a desk's risk limit accepts
  • Show what ignoring the sector does to the downside
3

Probability-weighted value

10 min

A deal either closes or it breaks. Weight each outcome by its chance and you know what the stock is worth to you, and what odds the market is pricing.

  • Calculate a stock's expected value from the close and break outcomes
  • Back out the probability of closing the market is pricing
  • Measure your edge against the market
  • Value the chance of a higher, competing bid
4

Rights issues and dilution

10 min

New shares sold to existing holders at a discount. The price falls, but a holder who acts loses nothing. The only way to lose is to do nothing.

  • Calculate the theoretical ex-rights price and the value of a right
  • Work out the new shares and the money raised
  • Find the subscription price that gives a target ex-rights price
  • Show that taking up and selling the rights leave a holder equally well off