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Video transcript
In the last couple of videos we set a scenario where company A intends to acquire company B. Their going to do it by issuing 2 million shares and then giving those 2 million shares to the shareholders of company B, and company B shareholders will give, essentially, all of their ownership away. Their will be an exchange 2 million of company A shares for 1 million of company B shares. On a [per search 0:24] share basis the owners of company B will give up one of their shares, and in exchange they will get 2 shares of company A. They will get 2 shares in company. We saw that if everyone thought that this transaction was going to happen, theoretically, whatever A is trading at B should trade at twice that. People know that they'll always be a little trade-in, or when the transaction happens there be a little trade-in of B for two of these A shares. What happens is a situation, or why would a situation happen where B doesn't trade at twice of A? This is a theoretical trading twice is A. This is 2 times A. What happens if it doesn't trade there? What happens if B's shares are trading ... let me do this in a color I haven't used before. What if it's trading a little bit lower there? Well, that might be the case, because some people don't think that the transactions going to happen. Their not willing to pay that full premium for B. Let's say that this were to happen, and you are working at some type of a hedge fund that has some type of model, maybe some mathematical model, maybe you have some type of shady information. Where you know for a fact, you are 100% certain, this transaction is going to close. It's definitely going to close with these terms. 2 million shares of A in exchange for 1 million shares of B. Your temptation might be, well, why don't I just buy these shares of B, because they will go up. What if the whole market goes down? What if the stock of A goes down like this? Then 2 times A will also go down. You don't want to just buy the stock of B thinking it's going to go up. If the transaction is really going to happen, B is just going to track 2 times the price of A. The best way to do it is to really set up a bit of a pair trade here. What you would do is if you think the transaction is definitely happening, you could buy 1 share ... let me write this down. You could buy 1 share of B. Share of B. You've gone long 1 share of B. Then you can short 2 shares of A. The reason why this will work, and this will only work if you know the transaction is going to happen, is because right now 2 shares of A are going to be ... at any point since B is trading a little bit of a discount to that, the 2 shares of A are going to be worth more than that the 1 share of B. When you sort 2 shares of A, maybe, where this point right here ... let's say that we are at this point on that day that everything was announced. When you short 2 shares of A, you're going to get $60. You're going to get $60. This is a review. You borrow the stock, you sell it, and you're going have to buy it back at some future date. You owe someone 2 shares of A. When you buy 1 share of B, it's not going to be trading at $60, it's going to be trading at some discount. Let's say that that cost you $55. It's trading a little bit of discount to 2 times A. Clearly just here, you have netted. $60 minus $55, you have netted $5. $5 net. Then assuming the transaction happens at some future date, when the transaction closes, that 1 share of B that you had, you can exchange it for 2 shares of A. You get 2 times A. Then you could use that to cover your short position. You use that to cover your short position, and you're left standing with $5. You essentially made ... well, there is a risk that the transaction didn't close, but assuming the transaction happened, this was kind of a [pedima 04:17] free $5 for your taking.