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Lecture 10

FINE 434 Lecture Notes - Lecture 10: Risk Arbitrage, Real Options Valuation, Short Squeeze

Course Code
FINE 434
Jiro Kondo

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Real option synergies
Real option synergies depend on some triggering event to produce a payoff.
Some examples:
- Growth option synergies:
o E.g., R&D, access to network.
- Exit option synergies:
o Arise from increased flexibility in altering investment strategies.
Estimating synergy value
Valuation of synergies in place happens with DCF method:
  
Some rules of thumb for synergy valuation:
- Establish credibility of the synergy source.
- Everything after tax.
- Use a terminal value to reflect extended synergy life:
 
 
Concluding remarks
Not all synergies are created equal.
Synergies are:
- Highest in horizontal deals.
- Middling in vertical combinations.
- Lowest in conglomerate deals.
Apply rigorous analysis and adopt a critical attitude.
Communication towards investors is very important.
Topic 10: Merger Arbitrage
Short selling: Definition

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The selling of a security that the seller does not own, or any sale completed by the delivery of a
security borrowed by the seller.
Short sellers assume that they will be able to buy the stock at a lower price than the price at
which they sold short.
This is an advanced trading strategy, with many unique risks and pitfalls. Novice investors are
advised to avoid short sales.
Short selling is done for two reasons:
- Hedging.
- Speculation.
Short selling: Players
Short sellers tend to be highly informed (i.e., they are capable of identifying overvalued stocks).
Players include:
- Wealthy individuals.
- Hedge funds.
- Large institutions.
- Day traders.
Short selling: Terminology
Short interest: The total number of shares of a security that have been sold short.
Short covering: Purchasing securities in order to close an open short position. This is done by
buying the same type and number of securities that were sold short.
Short squeeze: A situation in which a lack of supply and/or an excess demand for a traded stoc
forces the price upward.
Short selling: Pro or contra?
It is safe to say that short sellers are not the most popular people on Wall Street.
Many people consider short selling to be unethical.
Short selling indeed has a dark side (short and distort strategy).
However, short selling is in general very useful:
- Provide liquidity.
- Identify overvalued stocks.
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