Acme announces a merger agreement with Taco Company that will be completed in six months. Acme is offering 3 shares for every 4 shares of Taco.

Your risk arb firm would like to arb the spread in the deal in these two thinly traded stocks.

Your firm believes that despite rumors of a second bidder that in fact the deal will go exactly as announced.

Set up the arb using 800,000 shares as your position in Taco. You observe these prices in the market: Taco is $8 and Acme is $10.

1. What's the spread?

2. Which stock do you short and which do you long?

3. What is youe arbitrage profit if Acme stock goes to $15 when the deal is completed?

4. What is your profit or loss if the deal is abandonded and you see these prices.

Taco: $7

Acme: $12