Hello, everybody. It's Sam from Financial Samurai. And in this episode, we're going to talk about risk arbitrage investing and why if we practice risk arbitrage or arbitrage in our lives, we can lead better lives going forward. So risk arbitrage is an investment strategy that speculates on the successful completion of mergers and acquisitions.

This is the classic definition of risk arbitrage. An investor that employs the strategy is known as an arbitrageur. While risk arbitrage is a type of event-driven investing in that it attempts to exploit pricing inefficiencies caused by a corporate event. So during my 13 years on Wall Street, I covered hedge funds that deployed the risk arbitrage strategy.

And their bread and butter trade would be to go long a stock they thought would be a potential acquisition target and then go short either the company they thought would overpay or competitors that would be hurt from the acquisition. Or maybe they would buy competitors who they thought would also get acquired.

There's a multi-combination of risk arbing going on. And here's a classic example. Suppose Financial Samurai is trading at $40 a share. Then CNBC announces a plan to buy Financial Samurai, in which case holders of Financial Samurai stock get $80 in cash. Then Financial Samurai stock jumps to $70 a share.

It doesn't go to $80 since there is some chance the deal will not go through. The $10 spread is what an arbiter is playing for. In this case, the arbiter can purchase shares of Financial Samurai stock for $70. He will gain $10 if the deal is completed and lose $30 if the deal is terminated, assuming the stock returns to its original $40 in a break, which may not occur, which usually actually doesn't occur.

So according to the market, the probability that the deal is consummated at its original terms is about 75%. That's what the studies have shown in any kind of mergers and acquisitions. Once it's announced, 75% of the time, mergers happen. And the probability that the deal will be terminated is therefore 25%.

So the arbiter has three choices. Purchase Financial Samurai stock at $70. He would do this if he believes the probability that the deal will close is higher than or in line with the odds offered by the market. Short Financial Samurai stock at $70. She would do this if she believes the probability that the deal will be terminated is higher than the odds offered by the market, or simply not to get involved.

So that's an example of a risk arbitrage investment. And the reality is you can practice this type of risk arbitrage investing in your life by identifying arbitrage opportunities. For example, as an elementary schooler in Taipei, Taiwan, I would buy Nerds Candy at the US Commissary for $0.25 and then sell them for $0.50 to my classmates.

Does that sound good? Well, it was 100% profit. Was that morally right? Well, I was able to make some money, and actually all my classmates were happy because they would actually probably pay $0.75 or $1 because Nerds Candy was the number one candy on campus at the time. But eventually, other candy stores opened up and my profits were competed away.

Now, it wasn't just other stores that hurt my profits. It was my classmates. They were the ones who got smart and realized, hey, if Sam can make some money, we too can make some money. So every time my classmates went back to America during the summer vacations or winter vacations, they would bring back lots and lots of other candy and sell it to their classmates, who couldn't have the same opportunity going back to America.

And then what happened was inventory flooded the market, and then again, profits were whittled away. So if you are smart, you will be able to identify what other people are doing and try to compete for that remaining profit as well until it disappears. And then what you want to do is continuously look for new arbitrage opportunities.

So the current obvious no-brainer arbitrage opportunity, in my opinion, is going long online savings rates. So online savings rates are paying higher than bricks and mortar savings rates because they have less overhead. So a pure online bank, for example, like CIT Bank or Ally Bank or Synchrony Bank, all these banks have higher interest rates than a Citi Bank or Wells Fargo and so forth because they have less overhead.

And therefore, they can pass on their cost savings to consumers. If you can get an online savings rate higher than the risk-free rate of return, which is the 10-year bond yield, which is currently at about 1.55% to 1.75% at the end of 2019, that, to me, makes a ton, a ton of sense.

Back when the 10-year bond yield was at 3.21% in October 2018, one of the best online savings rate I could find was CIT Bank at 2.45%. I track CIT Bank closely because they are not only one of the best banks offering the highest rates, but they are also an affiliate partner.

And I get all their updates via email. So 2.45% online savings rate back then was competitive because the yield curve was upward sloping. Getting a higher risk-free rate would require owning a longer-term treasury bond until maturity. The reward for locking up your money for 10 years in a treasury bond was therefore 3.21%-- that's the 10-year treasury bond yield-- minus 2.45% what you could get at an online bank.

So that reward was 0.76% a year. And if you think about it, that is not that big of a reward. To lock up your money to earn a guaranteed 0.76% a year for the next 10 years-- not too enticing, but it is what it is. Given the 10-year bond yield is now down to about 1.65% since its 2018 peak at the time of this recording, you would think that CIT Bank's savings rate would be down a similar amount.

In fact, that's not the case at all, because as we know, the yield curve is kinked or inverted. The latest savings rate for CIT Bank at the time of this podcast recording is 2.2%, a decline of only 0.25% since its 2018 peak. Again, the 10-year bond yield declined by 1.65%.

In other words, 10-year treasury bond owners today are being negatively rewarded by 0.76%. Not only is the online savings depositor now earning about 0.64% more than the 10-year treasury bond holder, but there is also no lockup period and no risk up to the FDA-insured $250,000 per individual and $500,000 per couple.

I think this is one of the greatest risk-free arbitrage trades in modern financial history, because eventually, after CIT Bank and other banks providing a similar online interest rate have received enough inflows of deposits, they will lower their interest rates, and this opportunity will disappear. Now, if you want to take on more risk to potentially make more money, you can open up a high-interest savings account and then short long-term treasury bonds through an ETF like IEF.

The idea is to make money as rates go up on the 10-year or the long bond, because at 1.5%, 1.6%, I would say the chances are greater than 50% that interest rates are going to take a little bit higher. But again, who knows? You're going to take that risk, and you've got to weigh the risk and reward yourself.

So let me share some more history of money-making arbitrage opportunities that went on in my life, and I think it'll be really pertinent for you in your life or your children's lives. So one, I went to a public university for $2,800 a year in tuition. I saw my older sister attend a private university for $22,000 a year and saw no noticeable benefit.

In fact, attending a private university was probably a detriment, because my parents didn't make that much money as government employees. So the max arb here was going to one of the cheapest public universities and then getting a job in one of the most lucrative industries, which is finance. Even back in 1995, $2,800 a year sounded like a bargain, because I could cover the tuition working at my $4 an hour minimum wage job working at McDonald's.

And now, more than 20 years later, it's funny to see that people still believe there's a positive spread in attending a much more expensive private university than a public university. You heard about the college admissions scandals, where already very privileged and very wealthy people and parents are buying their kids' way into these schools that really mean nothing.

I don't want to denigrate private universities, but I'm saying, unless you're already rich or you have huge scholarships, please do the right thing and save your money and go to the best public school possible or the best value school possible. The reason why there's so much student loan debt, not only is because interest rates are higher than they should be, it's because parents and students aren't thinking about the ROI of going to school as much as they should.

They're seeing private school education, or maybe even college education as a whole, as some type of status symbol nowadays that's really, really not as necessary as it once was. So please, be prudent in your higher education decision. Two, buying property in San Francisco in 2003. I came to San Francisco with a raise and a promotion after two years in New York City.

At the time, the finance industry was thriving, and I realized plenty of other people were making just as much money as people in New York City. Yet San Francisco real estate was 30% cheaper on average than New York City real estate. This massive valuation discount was odd because I also found that the lifestyle in San Francisco to be much better.

The weather was pleasant year round, not just six or seven months a year. The city was more beautiful and less stressful. And after going snowboarding in two feet of powder on a Saturday in Lake Tahoe, three hours away, and then playing tennis in 70 degree weather on a Sunday, I was sold.

It was a no-brainer to live and own in San Francisco. And today, that price difference has basically narrowed or has gone away. And now, it's not unheard of to hear reports that San Francisco real estate is now equal to or more expensive than New York City real estate. Three, starting Financial Samurai in 2009.

After finishing up business school in 2006, it became more and more apparent that having an internet-based business with unlimited scale was the future. I just didn't know what to start. But when the financial crisis hit in 2009, I was like, OK, let's start Financial Samurai and try to make sense of the chaos.

I didn't recognize at the time any personal finance sites written by someone who actually had a finance background. This was really odd to me. And so as someone who had 10 years of finance experience at the time, starting my own site seemed like an opportunity. 10 years later, in 2019, there are still very few personal finance sites that are written by people with financial backgrounds for some reason.

Maybe the people in finance realize, you know what? It's much more lucrative to just continue to work in finance. For me, I was burnt out, and money wasn't the big driver anymore. I just wanted my freedom. So hey, I thought this would be a good idea to do something new with something that I'm quite familiar about.

Therefore, there are still opportunities for finance industry folks to engineer their layoffs and start a finance website. If you have experience in a field that is dominated by people without relevant experience, it behooves you to fill that hole. You must fill that hole, because that is massive arbitrage opportunity.

If you keep at it for a long enough period of time, I'm positive you will enjoy incredible rewards. Four, buying Panoramic Ocean View property in San Francisco. To me, this is one of the biggest, biggest opportunities for real estate investors anywhere. In no other major city in the world do Panoramic Ocean View homes trade at a discount.

And I've been everywhere. They all trade at hefty 30%, 100%, 200% premiums to the median price. The discount has since narrowed from about 30% in 2014 to about 15% in 2019. But I still see plenty of opportunity to buy property with views on the western side of San Francisco.

San Francisco is one of the cheapest international cities in the world. We have six-figure jobs that are a dime a dozen, because there are so many massively profitable companies here that's just generating huge amounts of cash flow. You know them all-- Facebook, Apple, Google, et cetera. It's just crazy how much you can make here if you get one of those jobs.

Whereas if you look at places like Vancouver, where the median price is quite similar to San Francisco, I don't know a single large international company that will pay that much money. I mean, can you name an international huge company out of Vancouver or out of Canada, for that matter?

It's hard to name it. And maybe it's because we're just dumb Americans. I'm not sure. But there is some valuation problems out there, in my belief. By 2025, the discount window for San Francisco View-based homes should narrow to 0%. That's my opinion. We're talking about a 240,000 arbitrage benefit based on the median priced home of 1.6 to 1.7 million.

In other words, 1.6 to 1.7 million times 15% is about 240,000. And that's not considering any upswing in the real estate market by then. And by 2030, Oceanview Homes in San Francisco should start trading at a premium, just like every single other international city in the world. I encourage you to drive around all around your city one weekend and see if you can find some neighborhood gems.

I'm sure there will be places you will have never seen or heard of before that will blow your mind. Five, investing in heartland real estate. Although there is a micro arbitrage opportunity to buy homes in SF with Oceanviews, there's a macro arbitrage opportunity to buy real estate in the heartland of America, mainly due to cost and technology.

Think about it. If it really takes $343,000 in household income to buy a median priced $1.6 million home in San Francisco, I don't know how many people are going to buy these homes or come to San Francisco. And I think the San Francisco based companies are going to get squeezed.

I have a close friend who employs 4,000 people in San Francisco. It's a publicly listed company. And he constantly tells me it is impossible to be competitive because the guys like Google and Facebook and Apple, they're paying such big bucks that it's just causing wage inflation for the rest of us.

Speaking of Google, they announced in early 2019 it'll spend $13 billion to expand in Nevada, Ohio, Texas, and Nebraska. Sounds like heartland real estate to me. Meanwhile, Uber in late 2019 announced it has leased an office building in Dallas for 3,000 employees. 3,000 employees. That's huge. And if that goes well, they're probably going to continue to expand.

So the key really is to find the next San Francisco, Seattle, New York City, and Washington DC. It's only logical that thanks to technology also, people are just telecommuting more. You don't have to live in a city center that costs-- where a two bedroom costs like $4,500 a month when you can live in a much lower cost area of the country.

So I believe there's going to be a multi-decade migration shift inland or simply to lower cost areas of the country. And you need to find that arbitrage trade. Finally, if you're a parent or you're a student, there's another great arbitrage for Americans. And that's to take advantage of the Canadians.

A top Canadian university has an acceptance rate of between 35% to 50%. Literally half the people get in. Whereas a top 10, top 20 university in America has an acceptance rate on average of 10% or below. So that acceptance rate spread is huge. It is really, really huge, folks.

So universities like UBC, McGill, University of Waterloo, if you don't want to kill yourself as a student or you want to hedge your bets when applying to college, apply to the top Canadian universities. Because once you get in, the reputation of these universities is pretty good. They're pretty good.

And you're going to get the similar types of opportunities and jobs as you would if you went to a top American university. And if you get Canadian residents, the cost is 80% to 90% cheaper. Now, international students have to pay much higher costs. But the costs are still about 10% to 20% cheaper than the most expensive private universities.

So hopefully you guys realize that after all these examples, there are arbitrage opportunities every single day, large and small. Take some time out of your week and dedicate at least one hour to figure one out. At the very least, everybody should take advantage of risk-free arbitrage opportunities, such as a higher online savings account with your excess cash.

My immediate focus now is paying attention to the San Francisco real estate market, which has softened in 2019. And I think there's a great opportunity to buy before a wave of tech IPO liquidity gets unleashed at the end of 2019 and in early 2020. I've spoken to dozens and dozens of employees from Uber, Lyft, Pinterest.

Some of them are happy. And actually, a lot of them are kind of disappointed. If you think about Uber in particular, there were talks pre-IPO of $100 billion market cap valuation. And right now, the stock is putting it at a valuation around $56 billion. So all those mental calculation models of thinking how rich you'd be after IPO, has really got to be changed, because a lot of employees are much less wealthy than they think they are.

And they're disappointed. And I want to go through this exercise and think, what would I do if I was an Uber employee who thought I was going to be worth $3 million, now I'm only worth, I don't know, $1 million, right? While also taking a pay cut for four years.

And I think I'd probably diversify and sell a little bit in 2019, and then sell a little bit more in 2020 to diversify my net worth, and also my tax liability. So for everybody else in America, I think there's a win of opportunity to buy property right now when rates are down, fears of recession are high, and a flood of money will be looking for a more stable asset.

I hope everybody enjoyed this podcast. It really has made me think about other opportunities instead of just being passive and sitting back and letting things come to me. Where I've gained the most amount of wealth is by taking action. So if you enjoyed this podcast, I hope to hear from you.

And please leave a positive review.