Creative Computers Ubid Arbitrage – how it works Hidden dangers

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Presentation transcript:

Creative Computers Ubid Arbitrage – how it works Hidden dangers MALL-UBID arbitrage MALL – UBID arbitrage Creative Computers Ubid Arbitrage – how it works Hidden dangers

MALL vs. UBID June 8, 1999 December 9, 1998 MALL-UBID arbitrage MALL vs. UBID June 8, 1999 Each Creative Computers shareholder receives 0.7159 UBID share for 1 MALL share December 9, 1998 MALL price is $22.75 UBID price is $35.6875 0.7159*$35.6875 = $25.55 UBID is more expensive than MALL !!! MALL-UBID arbitrage

MALL – UBID arbitrage December 9, 1998 Long 1 share of MALL at $22.75 Short 0.7159 shares of UBID at $25.55 This position is guarantees a “riskless” profit on June 8, 1999 !!! MALL-UBID arbitrage

Game Plan Dec 9 1998 Jun 8 1999 Investment Payoff Long 1 share MALL MALL-UBID arbitrage Game Plan Dec 9 1998 Jun 8 1999 Investment Payoff Long 1 share MALL $ 22.75 $ - Short 0.7159 shares of UBID $ (25.55) Short Cash Proceeds* $ 25.55 Long Margin Loan (cash) $ (11.38) $ (11.77) Short Margin Collateral (cash) $ 12.77 $ 13.03 Net (equity) $ 24.15 $ 26.81 11.00% <= 6m ROI Interest on short proceeds** 0.00% Margin loan interest - borrow 7.00% Margin loan interest - lend 4.00% * with broker ** rebate rate MALL-UBID arbitrage

Liabilities and Equity Liabilities and Equity MALL-UBID arbitrage Technical Details Long Position Short Position Assets Liabilities and Equity MALL (Long) value $ 22.75 Loan from broker*** $ 11.38 Cash* Equity (Net Worth) $ 11.37 Assets Liabilities and Equity UBID cash proceeds* $ 25.55 UBID (Short) value $ 25.55 Cash margin** $ 12.78 Equity (Net Worth) $ 12.78 MALL-UBID arbitrage

Liabilities and Equity MALL-UBID arbitrage Technical Details Joint Balance Sheet * with broker ** cash collateral *** long margin loan What Happens Next?... Assets Liabilities and Equity MALL (Long) value $ 22.75 Loan from broker*** $ 11.38 UBID cash proceeds* $ 25.55 UBID (Short) value $ 25.55 Short margin** $ 12.78 Equity $ 24.15 MALL-UBID arbitrage

MALL-UBID arbitrage

MALL-UBID arbitrage

MALL-UBID arbitrage

Liabilities and Equity MALL-UBID arbitrage Dec 18, 1998 – Margin Call Joint Balance Sheet * with broker ** cash collateral *** long margin loan Maintenance Equity Required: $18.63 Cash Infusion Required: $0.84 Assets Liabilities and Equity MALL (Long) value $ 28.88 Loan from broker*** $ 11.38 UBID cash proceeds* $ 25.55 UBID (Short) value $ 38.03 Short margin** $ 12.78 Equity $ 17.79 MALL-UBID arbitrage

MALL-UBID arbitrage

MALL-UBID arbitrage

MALL-UBID arbitrage

Liabilities and Equity MALL-UBID arbitrage Dec 23, 1998 – Margin Call #4 Joint Balance Sheet * with broker ** cash collateral *** long margin loan Maintenance Equity Required: $55.30 Cash Infusion Required: $103.26 Assets Liabilities and Equity MALL (Long) value $ 59.68 Loan from broker*** $ 11.38 UBID cash proceeds* $ 25.55 UBID (Short) value $ 134.59 Short margin** $ 12.78 Equity $ (47.96) MALL-UBID arbitrage

MALL-UBID arbitrage

MALL-UBID arbitrage

MALL-UBID arbitrage

How It Played Out… Dec 9 1998 Jun 8 1999 Investment Payoff MALL-UBID arbitrage How It Played Out… Dec 9 1998 Jun 8 1999 Investment Payoff Long 1 share MALL $ 22.75 $ 8.69 Short 0.7159 shares of UBID $ (25.55) $ - Short Cash Proceeds* $ 25.55 $ 25.55 Long Margin Loan (cash) $ (11.38) $ (11.77) Short Margin Collateral (cash) $ 12.77 $ 13.03 Cash infusions $ 103.26 $ 103.26 Net (equity) $ 127.41 $ 138.75 8.90% <= 6m ROI MALL-UBID arbitrage

How It Could Have Played Out… MALL-UBID arbitrage How It Could Have Played Out… Dec 9 1998 Jun 8 1999 Investment Payoff Long 1 share MALL $ 22.75 $ - Short 0.7159 shares of UBID $ (25.55) Short Cash Proceeds* $ 25.55 $ 25.55 Long Margin Loan (cash) $ (11.38) $ (11.77) Short Margin Collateral (cash) $ 12.77 $ 13.03 Cash infusions $ 103.26 $ 103.26 Net (equity) $ 127.41 $ 130.07 2.08% <= 6m ROI MALL-UBID arbitrage

Bottom Line Margin Trading and Short Selling amplify risk – be aware of margin calls Even if your long-term position is sound, you may be adversely affected in the short-term – always carry cash cushion Short-term adverse market move ruined LTCM in 1998, while their long-term bets were good MALL-UBID arbitrage