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Grasmere Asset Management Case Scenario
Fund B | The long-short fund seeks to profit from the market inefficiencies that may arise as a result of such corporate events as asset divestitures, mergers and acquisitions, special dividend payments, and share repurchases. The fund utilizes software that searches news sources to identify target companies that are then analyzed by the firm’s analysts. |
The analysts made the following points about the potential investments that Fund B might undertake. The fund should be interested in
- investing in the shares of a potential acquirer, even in a consolidating industry;
- taking a control position in a distressed company’s shares selling at a deep discount to its intrinsic value; and
- using its expertise to make long-term investments involving companies in reorganization.
Q. In the analysts’ discussion about Fund B’s potential investments, the point that is most accurate relates to:
A. reorganization opportunities.
B.positions in distressed companies.
C. acquisitions in a consolidating industry.
Solution
C is correct. Fund B fund seeks to profit from the market inefficiencies that may arise as a result of corporate events. It can hold either long or short positions in the acquiring and target companies as appropriate to produce a profitable position. This would be true even in consolidating industries as long as it believed that a market inefficiency existed.
Sir,
My doubt:
Since CFA Level 1, CFAI has programmed our brains to learn that we go long on target and short on the acquirer.
In this item set the how can the option favouring “investing in the shares of a potential acquirer” be the correct answer.
Can you please explain why C is correct?
Although option A cannot be the answer as it seems that it is a long-term strategy and option B is a distinct active management strategy. But answering based on elimination does not seem healthy.
So, sir can you please help me gain clarity.
The belief of the Hedge Fund manager may be that a merger in talks may not be successful, however, the market predicts otherwise. Thereby, the acquirer’s shares may be undervalued and the target’s may be overvalued. Hence, the manager may go long the acquirer and short the target.
The mandate of the fund is to generate profits from market inefficiencies that arise on account of corporate events by taking a long short position.
Here option A talks about going long on potential acquirer as it might have a view that the shares of the acquirer are selling cheap. The fund might take any position as it feels is appropriate to earn profit from inefficiency. This is very fund specific.
On a general sense it is correct though that we always go long on targets shares. I believe if there was such an option that must have been correct instead of this.
The fund can implement this even when two companies will merge into one, for instance co X and Z will consolidate into one. The fund will buy X or Z’s share if it believes the market inefficiency exists and it can earn profit that way.