Chapter 14Investing in Arbitrage

This chapter looks at a number of practical aspects of investing in merger arbitrage strategies. Some topics have been touched on earlier, such as short selling and leverage. Risk management is an area that has not yet been discussed. Despite its exponential growth in finance in general, the tools used in merger arbitrage are still rudimentary. Finally, different vehicles that investors can utilize to participate in merger arbitrage strategies are discussed.

Trading versus Investing

Merger arbitrage investments are held for a short period of time. As we saw in Chapter 5, the average time for the closing of a merger is 128 days. This short holding period qualifies merger arbitrage as a short-term trading strategy by the standards of most investors. For ultra-short-term traders who hold positions for a few days only or even as little as a few minutes or seconds, the time horizon of merger arbitrage is long. Most investors, however, have longer horizons and will consider merger arbitrage a short-term or trading strategy.

The short-term nature of merger arbitrage investing has implications on taxes, which have been discussed in Chapter 5. Merger arbitrage will generate primarily short-term gains and hence will be tax-inefficient. Many institutional investors are pension funds or endowments that are exempt from taxes and do not put much weight on the tax characteristics of merger arbitrage. Taxable individuals, however, often prefer to invest in ...

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