PORTFOLIO MANAGEMENT & ASSET ALLOCATION Case Solution
Question 1
a).
As a holder of the local Australian portfolio stocks, there would be certain risks and also certain benefits associated with the proposed acquisition and merger. First of all, if we talk about the risks of this share exchange, then the most significant risk for this stock for stock exchange for the proposed payment of the merger would dilute the equity of the current shareholders of Astro. The reason for this is that each shareholder of Astro would now be receiving four shares of Titi Company in exchange for one share of Astro, therefore, the total number of the outstanding shares for the new company would be higher and as a result, the equity of the current shareholders would be diluted which is a significant risk.
On the other hand, if we talk about the benefit of stock for stock exchange, then the benefit is that Astro would obtain all the liabilities and assets of Titi Company and this in turn would neutralize the effects of equity dilution to a great extent. Moreover, if the merger proves to be successful in the long term and yields significant synergies, then the shareholders of Astro would experience appreciation in their holdings of the assets of the new company. This would yield significant gains from this stock for stock exchange.
b).
The hedge fund is basically looking for a merger arbitrage and this is a type of event driver investing strategy for the company, which is based on exploiting the significant pricing differentials before or after the merger takes place. Due to the announcement of the merger between Astro and Titi Company, the share price of the Target Company would rise but at this time it would still be trading below the acquisition price. The benefit of this would be the risk free profit generated by the hedge fund. However, the risk with this strategy is that if the exchange ratio fluctuates before the merger then this opportunity would prove to be complex for the hedge fund.
Question 2
a).
The hedge fund is basically taking a directional trading strategy and the hedge fund now entails to take net short position within the market. A larger portion of the portfolio would be dedicated to the short positions. Therefore, the hedge fund is advised to reduce the undervalued stocks and buy the overvalued stocks. It is possible that the short position is going to decline in future and the long position is going to increase in value and if this happens then the hedge fund can benefit significantly. Finally, the maximum short position which could be taken by the hedge fund should be $ 10 million in addition to the 20% cash margin deposit for the value of the shares.
b).
The return percentage would be as follows:
$ 10 million x (1-10%)/ ($ 20 million x (1+2%-2%) = 45%.................
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