Revision Lecture Question 9:

A large manufacturing company has offered to purchase Composites, Inc. for $32 per share. Before the merger proposal announcement, Composites was trading at $20/share and, after the announcement, its share price jumped up to $28/share. It is estimated that, if the merger fails to go through, the price of Composites will drop to $15/share.

a) Assuming that the risk-free interest rate is 0%, how would you describe a long position in Composites as a combination of positions in a risk-free bond and a binary put option? Please show your workings in detail.

b) Assuming that the risk-free interest rate is 0%, how would you describe a long position in Composites as a combination of positions in a risk-free bond and a binary call option? Please show your workings in detial.

c) Please explain the event-driven strategies through the selling insurance view.