Suppose that it is March 6, 2000. You decide to exploit the negative stub of 3Com. For each share of 3Com stock, a shareholder will eventually receive 1.5 shares of Palm. Thus, you believe that P3Com 1:5PP alm

March 9 stock price 3com-$68.06...........................Palm-$69.375

July 28 stock price 3com-$12.937 .............................Palm-$37.25

a. Suppose that you believe that 3Com is fairly priced and that its stub value is $0 (i.e. its only value comes from Palm). What should Palm's price be in a market that is both frictionless and free from arbitrage?

b. Suppose that you now decide to exploit the negative stub value of 3Com. You short sell 150 shares of Palm and buy 100 shares of 3Com. You use the 3Com shares as collateral in the Palm short sale. What does your balance sheet look like? (i.e. What are your assets, liabilities, and equity?) What is your margin?

c. Jump ahead to March 9, 2000. What does your balance sheet look like?

d. If you are forced to unwind your position on March 9, 2000, what is your return?

e. Why is your return in the previous part negative even though this appears to be a clear arbitrage trading strategy? What would your return have been if you were able to hold the position until July 28, 2000 after 1.5 Palm shares were distributed for each 3Com share?