Merger Arbitrage Quiz
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The risk and returns of merger arbitrage investing are strongly influenced by:
Company growth rates and a stock's earnings per share.
Profitability and market share of industry competitors.
The successful or unsuccessful completion of a merger.
Daily market movements.
Question 1 Explanation:
Nice job! Merger Arbitrage’s risk and returns are almost entirely dependent on the “event," specifically the successful or unsuccessful completion of the merger or acquisition. This defining characteristic of merger arbitrage has historically led to low correlation with equity markets, which help to further diversify a portfolio.
If the Dow Jones Industrial Average rallies, gaining 2% in one day, more than likely, the SilverPepper Merger Arbitrage Fund will:
Be largely unaffected by the market move.
Because of the Fund’s low correlation, it will likely decline by 2%.
The Fund’s high beta will cause its returns to increase by 4%.
The Fund’s low beta will cause the returns to decrease by 4%.
Question 2 Explanation:
You got it! The day-to-day performance of the SilverPepper Merger Arbitrage Fund is driven primarily by any new developments in the mergers in which the Fund is invested. The Fund’s lower sensitivity to the gyrations of the market are a primary reason why this arbitrage opportunity exists. Long-only equity managers need to keep up with “the market” and typically sell companies that are involved in mergers, because the bulk of the merger premium has already been earned once the announcement becomes public.
Merger Arbitrage is called an “event-driven” strategy. What is an event and why is it important?
An event is a life changing moment for a company, its employees and its shareholders.
An event is all consuming for shareholders, and entirely dominates the behavior of the stock price.
The event is so powerful, if the market rises or falls, the stock price is largely unaffected.
All of the above.
Question 3 Explanation:
Yes, yes, yes! The “events” or, specifically, the mergers/acquisitions that the Fund is investing in tend to overshadow most broad market movements. The market's perception of whether the deal will close successfully or not is what drives the prices of the stocks involved, which is entirely different from what drives the price of a company that is not wrapped up in an event. When investors have a high level of confidence that the deal will close, the stock price will typically grind towards the announced deal price over the few weeks or months until the merger closes, moving independently from daily market movements.
Merger arbitrage is an investment strategy that seeks to earn a “spread.” Is the spread the difference between the price of the target stock prior to or after the merger announcement?
The spread is the difference between the price of the target stock prior to the merger announcement and the contractual price set by the acquiring company.
The spread is the difference between the price of the target stock after the merger announcement and the contractual price set by the acquiring company.
Question 4 Explanation:
Correct. You are on fire! Our manager, Brown Trout, only enters trades after a merger has been announced. They do not speculate on which companies might be bought or acquired in the future. By investing only in announced deals, the Fund should have much lower total risk (standard deviation or volatility) than funds that speculate on companies that may be acquired. While these spreads can look small relative to the significant jump in price after the announcement, the short-term nature of these deals means that assets can be continually reinvested in other deals several times throughout the year. The goal: "Dime after Dime, Time after Time."
The "spread" earned in merger-arbitrage investing is a function of all of the following EXCEPT:
Opportunity Risk: The risk-free rate that an investor passes up in order to participate in a risky merger arbitrage investment.
Time Risk: The amount of time it takes to close the merger. The longer the time, the higher the risk and return demanded.
Deal Risk: The amount of return necessary to compensate for the possibility that the merger may not close.
Systematic Risk: The amount of return necessary to compensate the merger arbitrage manager for the systematic, or market risk, for investing in the broad stock market.
Question 5 Explanation:
Hooray, you are right! For most stocks the majority of their day-to-day movements are related to systematic or market risk. For example, if you own a S&P 500 index fund, you are taking 100% systematic or market risk. And if you buy a stock, like IBM, absent any company specific news, that company’s stock price is up or down simply because “the market” is up or down. Importantly, merger arbitrage doesn’t have much market risk, because the share price of companies in the midst of a merger are largely responding to the all-consuming event and the special risks that the merger event poses.
In a cash merger, the merger arbitrage manager purchases the stock of the target company and, at the same time, creates a hedge by selling "short" the stock of the acquiring company?
Question 6 Explanation:
You nailed it! In this case, the movement of the acquiring company’s stock price doesn’t affect the spread because the deal is paid for in cash. Cash is cash. It's value doesn't need to be hedged. Only deals being paid for using the acquiring company’s stock need a short position to hedge out the risk that the acquiring company's stock falls in value. In addition, Brown Trout monitors the composition of the portfolio to ensure that the portfolio isn’t overexposed to one type of deal or the other—all-cash or all-stock deals.
SilverPepper is focused on offering hedge fund experts at mutual prices. Most hedge funds charge a management fee, typically 2%, and an incentive fee (typically 20% of the profits, above some minimum threshold). In contrast, the SilverPepper Merger Arbitrage Fund is accessible to all investors for:
2% management fee and a 20% incentive fee.
2% management fee and a 10% incentive fee.
1.5% management fee, with total expense ratio capped by the terms of the prospectus at 1.99%. There is no incentive fee for the Fund.
1.99% management fee and a 20% incentive fee.
Question 7 Explanation:
Bingo! SilverPepper funds don’t charge incentive fees on any of our Funds. Mutual funds typically don’t allow for incentive fees and SilverPepper doesn’t use loopholes to pass this fee on to its investors. Indeed, the Fund’s expenses are structured in such a way that as assets increase, the actual expense ratio will decrease from the initial 1.99% expense cap. Expenses are the most persistent and predictive component of a mutual-fund's returns. It makes sense that we want to drive down expenses of the Fund since we are investors in it. Hedge Fund Experts at Mutual Fund Prices, that's SilverPepper.
Chicago Capital Management, LLC, the subadvisor to the SilverPepper Merger Arbitrage Fund is:
A newly created investment management firm established in 2013.
A diversified investment management firm with investment capabilities in domestic large-cap stocks, diversified fixed-income, and emerging-market securities.
A traditional hedge fund manager that has specialized in merger arbitrage investing since 1998.
A fixed-income specialist with offices in London, New York, and Dubai.
Question 8 Explanation:
You got it right! SilverPepper seeks out experts who have years of experience in the field. The SilverPepper mutual funds are substantially similar to the privately-offered hedge funds that have been managed by our Sub-Advisors for the past 10+ years. While we can’t include this substantially similar performance of the hedge funds in our marketing materials, this related performance information can be found in our prospectus. This information does not suggest anything about future performance. But it might be helpful to you in becoming a more informed investor and help you ask the right questions to understand if the Fund may be a fit for your portfolio. Please review it along with the disclosure and other salient information provided in the Prospectus.
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