Definition of merger arbitrage

An investment strategy simultaneously buys and sells the stocks of two merging companies.

The profit is made from the spread, or difference, between a target company’s share price after a takeover announcement and the closing price at completion of the deal.

This is because during a takeover the stock of the acquiring company often falls while the stock of the target company rises.  So an M&A fund might both buy shares in the company being bid for and, to limit its risk, might sell - or short - shares in the bidder. If all goes to plan and the deal goes through, the fund will have made more from the increase in the target’s share price than it lost on the fall in value of the bidder.  [1]

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