Samson Co. announced its merger plans on October 25 and had a daily return of 0.7 percent. Thompson Co. announced its merger plans on October 26 and had a daily return of 0.4 percent. The Whitewood Co. announced its merger plans on October 27 and had a daily return of –0.6 percent. The daily market returns for October 25 through October 27 were 0.2, –0.3, and 0.4, respectively. What is the combined cumulative abnormal return for the announcement date?

0.11 percent

Explanation:

In finance, an abnormal return is obtained by deducting the expected return of a security or of a portfolio of security determined by the market performance from the actual return of the security or portfolio of security for certain period of time. Abnormal return can therefore be calculated as follows:

Abnormal return = Actual return - Expected return (1)

Factors that bring about abnormal return include increases in interest rate, announcement of dividends and earnings, lawsuits, and mergers.

On the other hand, cumulative abnormal return (CAR) is the addition of all abnormal returns of a security or a portfolio of security for some number of days.

Therefore, cumulative abnormal return (CAR) of stocks in the question can be calculated as follows:

Step 1: Calculate the Abnormal Return for each stock using equation (1)

For Samson Co.:

Actual return = 0.7 percent

Expected return = 0.2 percent

Abnormal return = 0.7 – 0.2

                            = 0.5 percent

For Thompson Co.:

Actual return = 0.4 percent

Expected return = –0.3 percent

Abnormal return = 0.4 – (–0.3)

                            = 0.4 + 0.3

                            = 0.7 percent

For Whitewood Co.:

Actual return = –0.6 percent

Expected return = 0.4 percent

Abnormal return = –0.6 + 0.4

                            = –0.2 percent

Step 2: Calculate the Cumulative Abnormal Return (CAR)

CAR is the addition of the abnormal returns of Samson Co., Thompson Co., and Whitewood Co., and this is calculated as follows:

CAR = 0.5 + 0.7 + (–0.2)

        = 0.13 – 0.2

        = 0.11 percent

Therefore, the combined cumulative abnormal return for the announcement date is 0.11 percent.

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