You are a risk arbitrageur and you observe the following information about a deal: the current price of the target is $20 per share and the current price of the bidder is $15 per share. The bidder is offering two bidder shares per target share, and you expect the deal to be completed in one year. Neither company is expected to pay dividends over the next year. Assume you can freely short sell and there are no margin requirements. You do not use any leverage.
a. i. Calculate the offer premium.
ii. Describe the transaction you will undertake to capture the premium.
iii. Show how your transaction will make money.
b. Is it possible that your actual return will be less than the expected return? Describe two situations that can cause the risk in risk arbitrage.