Question

Answer the following questions about trading strategies in efficiently inefficient markets.
(a) Discuss how active investors can be compensated for their information collection. Give examples of how you could try to collect information about specific firms and how you could trade on this.
(b) You work as an analyst at a hedge fund. Your manager suggests an investment strategy involving mergers and acquisitions (M&A). He provides anecdotes that suggest that the stock price of the target firm seems to go up once the deal is successful. He suggests a trading strategy that involves buying such firms right after the merger announcement, but before the actual merger. Should the hedge fund follow this trading strategy and, if so, what are the risks?
(c) Your manager also notes that the price of the target firm jumps right after the merger announcement. Suggest a trading strategy that might allow the hedge fund to profit from this occurence.

Answer 1

A) Informations plays a major role in investing and strategies because it depicts the fundamentals of a company. An investor who has information about a company which is overlooked or not yet disclosed then the investors can use the that information to gauge the stock price movement and gain by taking appropriate positions. A common source of information is a company’s quarter or annual financial statements which provides data of how the company performed and apart from that various media and research platforms also provides stock or industry information.

B &C) If a stock is about to go up after a merger announcement than best plan is to go through the financials of both the entities which are about to get merged and analyse the data to safeguard from some hidden valuation trap. If analysis is positive than one can buy small quantity before announcement and staggered the rest for after. This way one can actually benefit from prior information. The risk that is involved on buying after the announcement are not able to buy enough quantity because every one is chasing after it and if price goes higher than anticipated than there can be rapid selling to book the profits which makes the stock volatile.