In a recent Barron’s Flemington Meeks discusses a call he made last August 2008 on Liberty Entertainment (LMDIA) which holds 49.5% of DirecTV (DTV) and the Atlanta Braves and Starz Entertainment. He calculated that LMDIA was trading at a 25% discount to the value of its holdings. Reading between the lines, it looks like he recommended buying Liberty Media until it narrowed the discount. The result has been that LMDIA is up 4%. While DTV is down 13%.
If one instead bought Liberty and shorted DTV, then it wouldn’t have mattered how the discount narrowed. The simplest way to do that is to use a one factor model, and the wrong factor at that, the market as a whole.
The beta for LMDIA is 0.9 and the beta for DTV is 1.1. Beta measures how much a stock rises given a rise in the market, so LMDIA is a little more sluggish than the market and DTV is a little friskier.
LMDIA was $25 last August and DTV was around $28 so if you bought 1,000 shares of LMDIA and sold 900 of DTV to take into account the difference in beta and make the trade for no, or small, outlay of cash,
how would the trade have done?
DTV closed yesterday at 23.66 and LMDIA at $25.42. So the return on LMDIA was $420 and on DTV $3906. The bulk of the return would be on DTV if it could be borrowed.
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