# M&A hedging an equity portfolio against an index

Quick Note

This question was already posted under the userID user8170. Reason being I could not access my account. Now I am able to login to my account I am reposting the question here and will delete it from the profile user8170 (no comments or answers were posted anyway).

Question

I am trying to run a simple back test on a M&A strategy.

The idea is to buy the target company for the length of the deal and obviously hope to see a profit. The weight given to each deal is decided by the size of the deal.

Some of the deals are part cash, part equity in my study. I have a field in my data called 'Stock Exchange Ratio - Buyer Shares' (SER). This field is defined as the number of shares being issued by the acquirer to the target.

So for example if the acquirer called ABC is buying the target company called TAR in a part cash, part stock deal and the SER is 0.8. Then investors holding TAR will receive 0.8 shares of ABC for every TAR share they hold.

So when I have deals that are not 100% cash I will get extra equity exposure (from the acquirer) that I need to hedge as I understand it.

Rather than short every acquiring company and partly for simplicity I am going to short the MSCI World Index. I do not know how to calculate how much I need to hedge my portfolio against the index though? I have all the beta's for the acquiring companies.

  Portfolio

Acquirer Target  Deal Size    Weight      Stock Exchange Ratio - Buyer Shares
ABC      DEF     $1,000m 50% 0 MNO LMN$600m        30%         0.6
GHI      QRS     $400m 20% 2.5  Update The beta's for the 3 companies above are, ABC 0.93 MNO 1.11 GHI 1.14  - Luckily, these accounts can be merged. Please see this help page for more info. – Bob Jansen Aug 19 '14 at 8:42 "I have all the beta's for the acquiring companies." Could you show these aswell pls? – emcor Aug 21 '14 at 11:23 I have just added the beta's above. Need any further information please let me know – mHelpMe Aug 21 '14 at 11:54 I quickly glanced over your question. Two things before I can give it a shot: I think that there's information missing on whether the deal is going to be all-stock or not. I think the exchange ratio alone is not enough – pincopallino Aug 26 '14 at 11:01 @pincopallino if the exchange ratio is greater than zero please take that to be a deal is going to be part cash, part stock. As I understand it the exchange ratio just tells you how many stocks of the acquirer the holder of the target company will recieve – mHelpMe Aug 26 '14 at 13:52 ## 2 Answers If you are investing an amount$M$, split over deals indexed by$i$and with a weight$w_i$, then your dollar position in each share will be$w_i M$. The exposure to the index will be$\sum \beta_i w_i M\$

You should realize that this will not hedge idiosyncratic risks. In general, the more deals you have, the better this type of hedge should work (assuming the weights are in the same order of magnitude)

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I think u can hedge using the description given in JC hull.. here he uses index futures. A detailed explanation is given for one stock. I think u can extend it to a portfolio. Also one can hedge by combining two or three stock indices. See page 33 in this link http://www2.fiu.edu/~dupoyetb/Financial_Risk_Mgt/lectures/Ch03.pdf

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I checked that link and I dont see how it would be solution to the question. If you want the bounty, you gota simply answer the question by the given numbers. – emcor Aug 22 '14 at 13:59
i l try to solve with numbers from what i understood.. u l receive (dealsize/target_share_price)*SER shares of acquirer.. u l have total exposure of acquirer_share_price * (dealsize/target_share_price)*SER . add this to get your total exposure .. this gives ur Va in page 34. Now calculate the beta of your portfolio. now go to bloomberg and find the futures spot price of MSCi world index and find the contract size. Multiply these both. this will give u the vf.. thus u l find the number of future MSCI contracts to short(works for futures only) – lol Aug 25 '14 at 8:22