Repsol of Spain had agreed to acquire Talisman Energy, a Canadian oil and natural gas producer, for $8.3 billion in cash (or $9 per share), significantly expanding its portfolio of energy assets and production. The deal is expected to close in one year, during which Talisman is expected to pay a dividend of 5 cents. There is a 90% chance that the merger is successfully completed (all goes as planned). If the deal fails, the stock price is likely to drop to $4.00. Talisman Energy’s (TLM) shares are currently traded at a price of $8. The annual risk-free rate is 0.5%. You consider investing in this merger arbitrage transaction by buying Talisman’s shares.
(a) Compute the expected return and volatility for buying Talisman’s stock and hold- ing it for one year.
(b) What is the Sharpe ratio for this investment? Hint: recall that the Sharpe ratio
of investment i is given by E[ri]−rF . \sigma i