An acquirer offers Rs 400 cash per share for a target trading at Rs 370. If the deal breaks the target falls to Rs 300, and closing is six months away. What completion probability does the price imply, what is the annualised return if it closes, and how does the trade change if the offer is 0.8 acquirer shares instead?

The price implies a 70% chance the deal closes, about 83% after funding, and pays 8.1% in six months if it does, about 17% annualised. The trade risks 70 to make 30, so it only pays if your probability beats the market's. In a stock offer you buy Kiranveda and short 0.8 Ujjvalin shares per share, which locks the Rs 30 spread whatever Ujjvalin's price does, leaving only the deal risk.

Think of a ticket to an outdoor concert that might be cancelled for rain. If it is worth Rs 1,000 when the show goes ahead and Rs 200 as a refund if it is cancelled, a resale price of Rs 760 says the crowd thinks the show is 70% likely. The same arithmetic applies here: Rs 370 is a weighted average of Rs 400 if the deal closes and Rs 300 if it breaks, so 370 = p x 400 + (1 - p) x 300 and p = 0.70. Time value nudges this up. Holding the stock for six months costs funding, so the comparison is between 400 or 300 and 370 grown at 7% for half a year, Rs 382.95, which implies p = 0.829.

If the deal closes, buying at 370 and receiving 400 earns 8.11% in six months: 16.2% a year simple, or 16.9% compounded. If it breaks, the loss is 70, or 18.9%. The trade risks 70 to make 30, so at the market's own probability it earns roughly nothing beyond funding; it pays only if your estimate of completion is better than the market's. That is why merger arbitrage is a research business: the questions are about regulators, financing and shareholder votes. Annualised return figures look attractive, but they describe the outcome in which the deal closes, which is exactly the outcome you are being paid to doubt.

With 0.8 Ujjvalin shares per Kiranveda share and Ujjvalin at Rs 500, the offer is worth Rs 400 today, but its value at closing depends on Ujjvalin's price then. To lock the ratio rather than the price, buy one Kiranveda share and short 0.8 Ujjvalin shares: at closing your Kiranveda share becomes 0.8 Ujjvalin shares, which exactly covers the short, and you keep the Rs 30 spread whatever Ujjvalin did. Unhedged, a fall in Ujjvalin to 450 would turn the 30 into a loss of 10. The short also earns its proceeds back as the arbitrage closes, but it adds a new risk on a break: Ujjvalin often rises when it walks away, so a break that sends Kiranveda to 300 while Ujjvalin rallies to 520 costs 86 rather than 70.

State the limits. The break price of 300 is an estimate; if the stock has re-rated since the bid it may not fall that far, which raises the implied probability. Borrowing Ujjvalin shares has a cost and can be recalled. And deals rarely close on schedule: a three-month delay cuts the annualised return by a third even when the deal completes.