RelativeResourceManager solution

RelativeResourceManager solution - Professor Valery...

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Professor Valery Polkovnichenko 1 Practice questions for Midterm 1 Answers Finance 4346 Investment Management Professor Valery Polkovnichenko 1. Company A announced a merger with company B on February 13, 2006. In the all-stock deal each share in company B will be converted into 1.25 shares in company A. Right after the announcement A was traded at $50/share and B was traded at $60/share. Assume that initial margin (IM) is 60% and maintenance margin (MM) is 30% for short and margin purchase transactions. (a) Suggest a merger arbitrage strategy and calculate the maximum possible number of shares for short and long side for an investor who has $10,000 to commit to the strategy (round shares down to the whole number). For the long position assume that the investor will purchase shares on the margin. Merger arbitrage here involves shorting 1.25 shares of A for each purchase of share of B. As a result, SSP =1 . 25 × 50 = 62 . 5 and investor is required to pay SSP × IM =37 . 5. To purchase B on the margin investor pays $36 (= IM × $60) and takes the loan for the remaining amount of $24. The total investor must pay to set up a position is $73.50. With $10,000 investor can by 136 shares of B on margin (10000 / 73 . 5 = 148 . 05) and short sell 170 shares of A (136 × 1 . 25 = 170). (b) Later A is traded at $52 and B is traded at $58. Would investor get a margin call? Explain, answers without explanation will not be given credit. To determine whether the investor gets a margin call here we need to compute margin requirements and compare them to assets. Margin requirement for the loan is given by $24 / 0 . 7 = $34 . 29 and for the short 1.25 shares in A it is $52 × 1 . 25 × (1 + 0 . 3) = $84 . 5. So the total margin requirement is $118.79 (= $84 . 50 + $34 . 29). The assets include a share of B at $58 and SSP × (1 + IM )=62 . 50 × 1 . 6 = $100. The total of assets is $158 which is higher than the margin requirement of $118.79, so the investor does not get a margin call. 2. You own 100 shares of a company and when it opens at 36, you place the following orders (all for the same company you already own): Limit sell for 100 shares with limit price of 41 Stop-limit sell for 100 shares with stop price of 32 and limit price of 31 Stop buy for 100 shares with stop price of 39 By lunchtime the stock reached its intraday low of 32. Later in the afternoon it rebound, climbed back to its opening value and continued reaching intraday high of 41.40. About an hour later the stock closed trading at 38.90. How many shares do you own at the end of the day? Explain, answers without explanation will not be given credit. When the stock dips to $32 the stop-limit sell is triggered and since its limit price is lower than the subsequent prices, the order is executed. After that the investor has no shares left. As the stock climbs up and reaches $39 the stop buy is converted to market order and is executed because stock is still traded after that. So investor again owns 100 shares. Then, when the stock reaches
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RelativeResourceManager solution - Professor Valery...

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