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ExperimentalFinanceLecture-8F

ExperimentalFinanceLecture-8F - Experimental Finance IEOR...

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Experimental Finance IEOR – Spring 2012 Mike Lipkin, Pankaj Mody
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Experimental Finance Mike Lipkin, Alexander Stanton Page 2 Lecture 8f Take-Overs From time to time stocks are acquired for cash, stock, or some combination of the two. There are many scenarios for these deals: Big buyer, small target – Equals – Take-unders – Spin-offs Government intervention – Litigation – Friendly – Hostile Two-tier deal SDC Platinum (from Thomson Reuters) for Mergers & Acquisitions.
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Experimental Finance Mike Lipkin, Alexander Stanton Page 3 Lecture 8f Take-Overs The duration for completion of a deal can be brief, i.e. several months, or prolonged, i.e. several years. Because there are so many possible scenarios, we will content ourselves with a few choice observations, and also restrict the discussion to cash deals. January s [2006] cash-based takeovers (24 deals with a combined $15 billion purchase price) tripled 2005 s record level, according to Bloomberg. Kenneth L. Fisher, 03.27.06, Forbes.com. A typical cash deal involves a tender offer, by the acquirer, for all the stock of the acquiree, at a premium above the last traded price.
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Experimental Finance Mike Lipkin, Alexander Stanton Page 4 Lecture 8f Take-Overs The timeline for undisputed cash deals looks a little bit as follows:
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Experimental Finance Mike Lipkin, Alexander Stanton Page 5 Lecture 8f Take-Overs After a deal is announced the volatility surface of the acquiree becomes severely distorted. Why? The price of the target company moves up, but not to the take-over price. – Why? What does the price discount represent? Let s take a concrete example to examine the problem: AZZ acquires XYZ for cash, Jun 2008 (XYZ << AZZ) XYZ pre-takeover price, S 0 = 32.25 Target price, S ++ = 46.30 Post price, S + = 45.26 Pre-takeover, XYZ has flat vol profiles, σ = 35
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Experimental Finance Mike Lipkin, Alexander Stanton Page 6 Lecture 8f Take-Overs The following might be a typical vol profile after the announcement: σ (Jun 30) = 8, σ (Jun 32.5) = 10, σ (Jun 35) = 35, σ (Jun 37.5) = 60, σ (Jun 40) = 75, σ (Jun 45) = 75, σ (Jun 50) = 8. σ (Jul ) = similar to Jun σ (outer months) << Jul, σ (outer 45 s) not large. Why? Specifically, why are some vols so low and others very high? What would happen if the deal doesn t go through? Why might this happen?
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Experimental Finance Mike Lipkin, Alexander Stanton Page 7 Lecture 8f Take-Overs Now let s consider some delicate questions. What would be the consequence of insider trading before a take- over? What if there were take-over rumors whether they were founded on fact or not? Can insider trading be reinforced in the options markets? The answer to the last question is YES.
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Experimental Finance Mike Lipkin, Alexander Stanton Page 8 Lecture 8f Take-Overs To get an idea of the consequences of leaked deals and insider trading on the options markets, we need to think about the result of a deal on an option portfolio.
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