Risk Arbitrage!

The Details
On Tuesday, 7 March 2000 VeriSign (VRSN) announced that it had agreed to purchase Network
Solutions (NSOL) at a rate of 2.15 shares of VRSN to each share of NSOL. Before the deal, at
Monday's close VRSN was trading at $247.4375 and NSOL was at $360.625. The exchange rate
meant that VRSN was paying about $532 for each share of NSOL. Forget the fact that both of these
companies are currently unbelievably, extremely overvalued (superlatives fail me here). All good
capitalists have to ask, "How can I profit from this deal in a risk-free way?" The answer is risk
arbitrage (its not a pure arbitrage because some risk remains). This spreadsheet shows how you
could make a very nice nearly risk free return if the deal remains unchanged and closes at the end of
the third quarter as expected (that, of course, is the remaining risk). All you have to do is to short
2.15 shares of VRSN for each share of NSOL that you buy. We'll assume that you buy 100 NSOL
and therefore you short 215 VRSN.

Too see why this works, please read the comments in the cells as you work through this spreadsheet.

VRSN NSOL
Pre-Deal Price 247.44 360.63
Current Prices 209.00 418.00
The Deal 2.15 1.00
Pre-Announcement Value 247.44 531.99
Value at Current Prices 209.00 449.35
Potential Premium at Original Prices 0.00 171.37
Premium at Current Prices 0.00 31.35
Shares -215.00 100.00
Net Investment in Arbitrage -44935.00 41800.00
Today's Date 07-Mar-00
Closing Date 29-Sep-00
Total Expected Return to Closure 7.50%
Annualized Return 13.67%
Probability of Deal's Success 64.67%
Again, to put on this arbitrage you buy 100 NSOL (the target) and short 100 x 2.15 = 215 VRSN (the
acquiring company). This will lock in the "Premium at Current Prices" regardless of where VRSN's
stock goes. Here's a table that proves that statement. Note that the deal is expected to close at the
end of the third quarter (29 September 2000, 206 days from today). The stock prices shown here are
potential prices as of that date, assuming that the deal goes through unchanged. Notice that no matter
how good or bad it gets for VRSN shareholders, you will lock in a gain of $3,150.

Stock Prices and Net Gain at Deal Closure

VRSN NSOL Gain on VRSN Gain on NSOL
250 537.50 -88.15 119.5
 240 516.00 -66.65 98
230 494.50 -45.15 76.5
220 473.00 -23.65 55
210 451.50 -2.15 33.5
200 430.00 19.35 12
190 408.50 40.85 -9.5
180 387.00 62.35 -31
170 365.50 83.85 -52.5
160 344.00 105.35 -74
150 322.50 126.85 -95.5
140 301.00 148.35 -117
130 279.50 169.85 -138.5
120 258.00 191.35 -160
110 236.50 212.85 -181.5
100 215.00 234.35 -203
90 193.50 255.85 -224.5
80 172.00 277.35 -246
70 150.50 298.85 -267.5
60 129.00 320.35 -289
50 107.50 341.85 -310.5
40 86.00 363.35 -332
30 64.50 384.85 -353.5
20 43.00 406.35 -375
10 21.50 427.85 -396.5

Remember, this is not a totally risk-free trade. That's why its called risk
arbitrage and not just arbitrage. The risk is that the deal will fall through
(if either set of shareholders reject it), that it will take longer than
expected to close, or that the exchange rate will fall to a lower amount
than 2.15 shares. Your goal here is simply to earn a rate of return higher
than the risk-free rate (say, about 6% right now for a year) plus a small
premium for the risk that you are taking on. Your annualized return is
13.67%, giving you a premium of 7.67% over the risk-free rate. That
sounds to me like more than enough of a premium. How often can you
get a fat, practically risk-free premium on an internet stock?
Closure
Net Gain
31.35
 31.35
31.35
31.35
31.35
31.35
31.35
31.35
31.35
31.35
31.35
31.35
31.35
31.35
31.35
31.35
31.35
31.35
31.35
31.35
31.35
31.35
31.35
31.35
31.35

at's why its called risk

e deal will fall through
ake longer than
ll to a lower amount
a rate of return higher
r a year) plus a small
r annualized return is
risk-free rate. That
m. How often can you
net stock?
 Net Gain on Arb
40

35
Net Gain on Arb at Closure

30
Column F

25

20
10 20 30 40 50 60 70 80 90 100 110 120 130 140 150 160 170 180 190 200 210 220 230 240 250
VRSN Stock Price at Closure
 Risk Arbitrage!
At the close that same day:

The spread had tightened during the day so that by the close only $22.63 was available to be had in
this arbitrage. That reduced the annualized return to 10.05%, but the probability of success -- as
judged by the market -- had barely increased. This reduces the risk/return tradeoff and makes the
deal less attractive. It still looked good however.

VRSN NSOL
Pre-Deal Price 247.44 360.63
Current Prices 200.00 407.38
The Deal 2.15 1.00
Pre-Announcement Value 247.44 531.99
Value at Current Prices 200.00 430.00
Potential Premium at Original Prices 0.00 171.37
Premium at Current Prices 0.00 22.63
Shares -215.00 100.00
Net Investment in Arbitrage -43000.00 40737.50
Today's Date 07-Mar-00
Closing Date 29-Sep-00
Total Expected Return to Closure 5.55%
Annualized Return 10.05%
Probability of Deal's Success 67.39%
Again, to put on this arbitrage you buy 100 NSOL (the target) and short 100 x 2.15 = 215 VRSN (the
acquiring company). This will lock in the "Premium at Current Prices" regardless of where VRSN's
stock goes. Here's a table that proves that statement. Note that the deal is expected to close at the
end of the third quarter (29 September 2000, 206 days from today). The stock prices shown here are
potential prices as of that date, assuming that the deal goes through unchanged. Notice that no matter
how good or bad it gets for VRSN shareholders, you will lock in a gain of $2,262.50.

Stock Prices and Net Gain at Deal Closure

VRSN NSOL Gain on VRSN Gain on NSOL
250 537.50 -107.5 130.13
240 516.00 -86 108.63
230 494.50 -64.5 87.13
220 473.00 -43 65.63
210 451.50 -21.5 44.13
200 430.00 0 22.63
190 408.50 21.5 1.13
180 387.00 43 -20.38
170 365.50 64.5 -41.88
160 344.00 86 -63.38
 150 322.50 107.5 -84.88
140 301.00 129 -106.38
130 279.50 150.5 -127.88
120 258.00 172 -149.38
110 236.50 193.5 -170.88
100 215.00 215 -192.38
90 193.50 236.5 -213.88
80 172.00 258 -235.38
70 150.50 279.5 -256.88
60 129.00 301 -278.38
50 107.50 322.5 -299.88
40 86.00 344 -321.38
30 64.50 365.5 -342.88
20 43.00 387 -364.38
10 21.50 408.5 -385.88

Remember, this is not a totally risk-free trade. That's why its called risk
arbitrage and not just arbitrage. The risk is that the deal will fall through
(if either set of shareholders reject it), that it will take longer than
expected to close, or that the exchange rate will fall to a lower amount
than 2.15 shares. Your goal here is simply to earn a rate of return higher
than the risk-free rate (say, about 6% right now for a year) plus a small
premium for the risk that you are taking on. Your annualized return is
13.67%, giving you a premium of 7.67% over the risk-free rate. That
sounds to me like more than enough of a premium. How often can you
get a fat, practically risk-free premium on an internet stock?
Closure
Net Gain
22.63
22.63
22.63
22.63
22.63
22.63
22.63
22.63
22.63
22.63
 22.63
22.63
22.63
22.63
22.63
22.63
22.63
22.63
22.63
22.63
22.63
22.63
22.63
22.63
22.63

at's why its called risk

e deal will fall through
ake longer than
ll to a lower amount
a rate of return higher
r a year) plus a small
r annualized return is
risk-free rate. That
m. How often can you
net stock?
 Risk Arbitrage!
At the open the next day:

The deal actually got better overnight. The spread widened so that you could now lock in $37.50 per
share of NSOL, but the probability of success for the deal had declined. The annualized return is
now 16.69%. Quite attractive.

VRSN NSOL
Pre-Deal Price 247.44 360.63
Current Prices 210.00 414.00
The Deal 2.15 1.00
Pre-Announcement Value 247.44 531.99
Value at Current Prices 210.00 451.50
Potential Premium at Original Prices 0.00 171.37
Premium at Current Prices 0.00 37.50
Shares -215.00 100.00
Net Investment in Arbitrage -45150.00 41400.00
Today's Date 08-Mar-00
Closing Date 29-Sep-00
Total Expected Return to Closure 9.06%
Annualized Return 16.69%
Probability of Deal's Success 58.73%
Again, to put on this arbitrage you buy 100 NSOL (the target) and short 100 x 2.15 = 215 VRSN (the
acquiring company). This will lock in the "Premium at Current Prices" regardless of where VRSN's
stock goes. Here's a table that proves that statement. Note that the deal is expected to close at the
end of the third quarter (29 September 2000, 205 days from today). The stock prices shown here are
potential prices as of that date, assuming that the deal goes through unchanged. Notice that no matter
how good or bad it gets for VRSN shareholders, you will lock in a gain of $3,750.

Stock Prices and Net Gain at Deal Closure

VRSN NSOL Gain on VRSN Gain on NSOL
250 537.50 -86 123.5
240 516.00 -64.5 102
230 494.50 -43 80.5
220 473.00 -21.5 59
210 451.50 0 37.5
200 430.00 21.5 16
190 408.50 43 -5.5
180 387.00 64.5 -27
170 365.50 86 -48.5
160 344.00 107.5 -70
 150 322.50 129 -91.5
140 301.00 150.5 -113
130 279.50 172 -134.5
120 258.00 193.5 -156
110 236.50 215 -177.5
100 215.00 236.5 -199
90 193.50 258 -220.5
80 172.00 279.5 -242
70 150.50 301 -263.5
60 129.00 322.5 -285
50 107.50 344 -306.5
40 86.00 365.5 -328
30 64.50 387 -349.5
20 43.00 408.5 -371
10 21.50 430 -392.5

Remember, this is not a totally risk-free trade. That's why its called risk
arbitrage and not just arbitrage. The risk is that the deal will fall through
(if either set of shareholders reject it), that it will take longer than
expected to close, or that the exchange rate will fall to a lower amount
than 2.15 shares. Your goal here is simply to earn a rate of return higher
than the risk-free rate (say, about 6% right now for a year) plus a small
premium for the risk that you are taking on. Your annualized return is
13.67%, giving you a premium of 7.67% over the risk-free rate. That
sounds to me like more than enough of a premium. How often can you
get a fat, practically risk-free premium on an internet stock?
Closure
Net Gain
37.5
37.5
37.5
37.5
37.5
37.5
37.5
37.5
37.5
37.5
 37.5
37.5
37.5
37.5
37.5
37.5
37.5
37.5
37.5
37.5
37.5
37.5
37.5
37.5
37.5

at's why its called risk

e deal will fall through
ake longer than
ll to a lower amount
a rate of return higher
r a year) plus a small
r annualized return is
risk-free rate. That
m. How often can you
net stock?
 Risk Arbitrage!
24 hours after our first check on this deal:

The deal actually narrowed considerably after the open. The spread narrowed so that you could now
lock in $19.47 per share of NSOL, but the probability of success for the deal had declined even
further. The annualized return is now 9.18%. The deal might be attractive at these prices, but its
getting close. Imagine how you would feel as an unhedged shareholder of either company at this
point.

VRSN NSOL
Pre-Deal Price 247.44 360.63
Current Prices 188.13 385.00
The Deal 2.15 1.00
Pre-Announcement Value 247.44 531.99
Value at Current Prices 188.13 404.47
Potential Premium at Original Prices 0.00 171.37
Premium at Current Prices 0.00 19.47
Shares -215.00 100.00
Net Investment in Arbitrage -40446.88 38500.00
Today's Date 08-Mar-00
Closing Date 29-Sep-00
Total Expected Return to Closure 5.06%
Annualized Return 9.18%
Probability of Deal's Success 55.60%
Again, to put on this arbitrage you buy 100 NSOL (the target) and short 100 x 2.15 = 215 VRSN (the
acquiring company). This will lock in the "Premium at Current Prices" regardless of where VRSN's
stock goes. Here's a table that proves that statement. Note that the deal is expected to close at the
end of the third quarter (29 September 2000, 205 days from today). The stock prices shown here are
potential prices as of that date, assuming that the deal goes through unchanged. Notice that no matter
how good or bad it gets for VRSN shareholders, you will lock in a gain of $3,750.

Stock Prices and Net Gain at Deal Closure

VRSN NSOL Gain on VRSN Gain on NSOL
250 537.50 -133.03 152.5
240 516.00 -111.53 131
230 494.50 -90.03 109.5
220 473.00 -68.53 88
210 451.50 -47.03 66.5
200 430.00 -25.53 45
190 408.50 -4.03 23.5
180 387.00 17.47 2
170 365.50 38.97 -19.5
160 344.00 60.47 -41
 150 322.50 81.97 -62.5
140 301.00 103.47 -84
130 279.50 124.97 -105.5
120 258.00 146.47 -127
110 236.50 167.97 -148.5
100 215.00 189.47 -170
90 193.50 210.97 -191.5
80 172.00 232.47 -213
70 150.50 253.97 -234.5
60 129.00 275.47 -256
50 107.50 296.97 -277.5
40 86.00 318.47 -299
30 64.50 339.97 -320.5
20 43.00 361.47 -342
10 21.50 382.97 -363.5

Remember, this is not a totally risk-free trade. That's why its called risk
arbitrage and not just arbitrage. The risk is that the deal will fall through
(if either set of shareholders reject it), that it will take longer than
expected to close, or that the exchange rate will fall to a lower amount
than 2.15 shares. Your goal here is simply to earn a rate of return higher
than the risk-free rate (say, about 6% right now for a year) plus a small
premium for the risk that you are taking on. Your annualized return is
13.67%, giving you a premium of 7.67% over the risk-free rate. That
sounds to me like more than enough of a premium. How often can you
get a fat, practically risk-free premium on an internet stock?
Closure
Net Gain
19.47
19.47
19.47
19.47
19.47
19.47
19.47
19.47
19.47
19.47
 19.47
19.47
19.47
19.47
19.47
19.47
19.47
19.47
19.47
19.47
19.47
19.47
19.47
19.47
19.47

at's why its called risk

e deal will fall through
ake longer than
ll to a lower amount
a rate of return higher
r a year) plus a small
r annualized return is
risk-free rate. That
m. How often can you
net stock?
 Risk Arbitrage!
After 24 hours have gone by, here's what would have happened had you put on this
arbitrage at the beginning:

You purchased 100 shares of NSOL at $418 for a total investment of $41,800. This
position is now worth only $385 per share, or $38,500. You have a loss on NSOL of
$3,300.

However, you shorted 215 shares of VRSN at $209, or $44,935. That position is now
worth $188.13 share, or $40,446.88. Since you are short, you have a gain here of
$4,488.125.

Your net gain after 24 hours is $1,188.125 even though both stocks have suffered large
declines in value. NSOL has dropped by 7.9% and VRSN has dropped by 9.99%, but
you are still showing a gain! No matter what happens to the stocks, your gain will only
increase as we approach the closing date for this deal if the deal doesn't fall apart or
change against your position (i.e., the ratio declines). Not bad for a simple trade.
 Risk Arbitrage!
The End of the Trade

The deal actually closed after the end of trading on 8 June 2000. After the deal was announced,
NSOL split its stock 2 for 1 which changed the ratio to 1.075 VRSN shares per NSOL share. This
event had no impact on the trade and no action was necessary.

This page shows the results had you put on the arbitrage at the prices that were current at the time I
originally created this spreadsheet. This page is the same as the first one, but I have changed the
closing date of the deal to 9 June 2000. Other than that, everything is the same. I have not adjusted
for the split or price changes for the deal because neither one has any impact on your return once
you've put the trade on.

Just for your information, on 8 June 2000 NSOL ended trading at 201.25 (402.50 on a pre-split basis)
and VRSN ended at 196.375. Note that had you been unhedged, you would have lost a substantial
amount of money on VRSN stock. VRSN shareholders lost 51.0625 per share between the
announcement and closure. NSOL holders would have made 41.875 per pre-split share. That
represents a holding period return of 11.612% if you had just bought NSOL immediately before the
deal. Had you bought on 7 March 2000 (the date when I put this together) however, you would have
lost 3.708%. Obviously, if you had been an existing NSOL holder, you would have been slightly
better off remaining unhedged. More likely, though, if you had bought NSOL alone (without shorting
VRSN), you would have been much worse off. The risk arbitrage position eliminated this risk.

VRSN NSOL
Pre-Deal Price 247.44 360.63
Current Prices 209.00 418.00
The Deal 2.15 1.00
Pre-Announcement Value 247.44 531.99
Value at Current Prices 209.00 449.35
Potential Premium at Original Prices 0.00 171.37
Premium at Current Prices 0.00 31.35
Shares -215.00 100.00
Net Investment in Arbitrage -44935.00 41800.00
Today's Date 07-Mar-00
Closing Date 09-Jun-00
Total Expected Return to Closure 7.50%
Annualized Return 32.42%
Probability of Deal's Success 64.67%
Again, to put on this arbitrage you buy 100 NSOL (the target) and short 100 x 2.15 = 215 VRSN (the
acquiring company). This will lock in the "Premium at Current Prices" regardless of where VRSN's
stock goes. Here's a table that proves that statement. Note that the deal is expected to close at the
end of the third quarter (29 September 2000, 206 days from today). The stock prices shown here are
potential prices as of that date, assuming that the deal goes through unchanged. Notice that no matter
how good or bad it gets for VRSN shareholders, you will lock in a gain of $3,150.
Again, to put on this arbitrage you buy 100 NSOL (the target) and short 100 x 2.15 = 215 VRSN (the
acquiring company). This will lock in the "Premium at Current Prices" regardless of where VRSN's
stock goes. Here's a table that proves that statement. Note that the deal is expected to close at the
end of the third quarter (29 September 2000, 206 days from today). The stock prices shown here are
potential prices as of that date, assuming that the deal goes through unchanged. Notice that no matter
how good or bad it gets for VRSN shareholders, you will lock in a gain of $3,150.

Stock Prices and Net Gain at Deal Closure

VRSN NSOL Gain on VRSN Gain on NSOL
250.00 537.50 -88.15 119.50
240.00 516.00 -66.65 98.00
230.00 494.50 -45.15 76.50
220.00 473.00 -23.65 55.00
210.00 451.50 -2.15 33.50
200.00 430.00 19.35 12.00
190.00 408.50 40.85 -9.50
180.00 387.00 62.35 -31.00
170.00 365.50 83.85 -52.50
160.00 344.00 105.35 -74.00
150.00 322.50 126.85 -95.50
140.00 301.00 148.35 -117.00
130.00 279.50 169.85 -138.50
120.00 258.00 191.35 -160.00
110.00 236.50 212.85 -181.50
100.00 215.00 234.35 -203.00
90.00 193.50 255.85 -224.50
80.00 172.00 277.35 -246.00
70.00 150.50 298.85 -267.50
60.00 129.00 320.35 -289.00
50.00 107.50 341.85 -310.50
40.00 86.00 363.35 -332.00
30.00 64.50 384.85 -353.50
20.00 43.00 406.35 -375.00
10.00 21.50 427.85 -396.50

Remember, this is not a totally risk-free trade. That's why its called risk
arbitrage and not just arbitrage. The risk is that the deal will fall through
(if either set of shareholders reject it), that it will take longer than
expected to close, or that the exchange rate will fall to a lower amount
than 2.15 shares. Your goal here is simply to earn a rate of return higher
than the risk-free rate (say, about 6% right now for a year) plus a small
premium for the risk that you are taking on. Your annualized return is
13.67%, giving you a premium of 7.67% over the risk-free rate. That
sounds to me like more than enough of a premium. How often can you
get a fat, practically risk-free premium on an internet stock?
 Closure
Net Gain
31.35
31.35
31.35
31.35
31.35
31.35
31.35
31.35
31.35
31.35
31.35
31.35
31.35
31.35
31.35
31.35
31.35
31.35
31.35
31.35
31.35
31.35
31.35
31.35
31.35

at's why its called risk

e deal will fall through
ake longer than
ll to a lower amount
a rate of return higher
r a year) plus a small
r annualized return is
risk-free rate. That
m. How often can you
net stock?