A large Canadian institutional investor is considering a significant allocation to a hedge fund that employs an event-driven strategy. The fund manager specializes in merger arbitrage. Which of the following situations poses the greatest risk to this strategy?

Question: A large Canadian institutional investor is considering a significant allocation to a hedge fund that employs an event-driven strategy. The fund manager specializes in merger arbitrage. Which of the following situations poses the greatest risk to this strategy?

Answer options:

• A general downturn in global equity markets.
• An unexpected increase in corporate tax rates. ✅ The target company's shareholders rejecting the proposed acquisition.
• Increased competition from other merger arbitrage funds.

Correct answer: The target company's shareholders rejecting the proposed acquisition.

Explanation: Merger arbitrage strategies profit from the spread between the announced acquisition price and the target company's current stock price. If the merger fails (e.g., shareholders reject it), this spread can evaporate or reverse, leading to significant losses for the fund, making it the greatest specific risk.