In October 2009, Ares Capital Corporation (ARCC) announced that it was acquiring Allied Capital (ALD). The terms of the acquisition specified that one share of ALD would become 0.325 share of ARCC. Prior to the announcement, the closing daily prices of the two stocks were the following:

Days Prior to Announcement ALD ARCC 4 $2.85 $10.81 3 2.82 10.60 2 2.85 10.89 1 2.73 10.69 After the announcement, the closing daily prices of the two stocks were the following:

Days After Announcement ALD ARCC 1 $3.61 $11.99 2 3.52 11.73 3 3.20 10.61 4 3.38 11.19

a) What is the value of ALD stock in terms of ARCC stock prior to the announcement?

b) What is the value of ALD stock in terms of the closing prices of ARCC after the announcement? Is there a difference between the actual price of ALD and its value in terms of ARCC?

c) A hedge fund manager believes the difference in pricing offers an opportunity for arbitrage. On the day of the announcement, this portfolio manager establishes two positions by purchasing 1,000 shares of ALD and selling 325 shares of ARCC short. What is the cash inflow and cash outflow from the two positions?

d) If the acquisition is completed, what are the profits or losses on the two positions for the following prices of ARCC: $8, 9, 10, 11, and 12?

e) What is the potential profit or loss if the acquisition is canceled and the stocks return to their prices prior to the announcement?