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In hedge funds, an investment strategy related to mergers and acquisitions involving the purchase and/or shorting of an acquired company's stock. In a cash merger, the stock of the acquired company often trades below the offer price until the deal is completed. A hedge fund may buy at the lower price and wait for the deal to be completed, at which point it makes a profit. In a stock-for-stock merger, the acquiring company (with more valuable stock) offers to exchange the acquired company's stock for its own at a certain ratio. A hedge fund may then short sell the acquiring company's stock while simultaneously buying stock in the acquired company. When the deal goes through, the acquired company's stock is converted and the new stock returned to the owner from which the hedge fund borrowed. In both these situations, the primary risk is the possibility that the deal may fail in the middle of the hedge fund's transactions. See also: Exchange ratio.
See risk arbitrage.