Merger arbitrage is a risk-arbitrage investment strategy that consists of buying the stock of a target company involved in a merger or acquisition and simultaneously selling the stock of the target’s acquirer. When the deal closes and the merger or acquisition is completed, the investor will be left with half the purchase price of the target company in the acquirer’s stock.

The purpose of merger arbitrage is to take advantage of temporary price discrepancies between the acquirer’s stock and the target’s stock in a merger or acquisition. In theory, when the merger is finished, the stocks of both the acquirer and the target should reach a certain equilibrium price. Investors who have successfully executed a merger-arbitrage strategy by buying the target and selling the acquirer usually realize a small gain.

Merger arbitrage involves a certain amount of risk. The most common is the risk that the deal does not go through as planned, or that the acquisition or merger is abandoned altogether. If that happens, the stock of the target company would drop, leading to a loss for the investor. Another risk is that the merger or acquisition is delayed, leading to a significant price change in the stocks of the target and the acquirer before the merger is completed.

Merger arbitrage is, in most cases, a relatively low-risk yet profitable investment strategy. It is, however, a highly specialized investment strategy that requires the investor to have detailed knowledge of the target company, the acquirer and the merger or acquisition process. It’s best suited for experienced investors who have the knowledge and expertise required to accurately assess the risk of a given merger or acquisition.