On July 20th I highlighted the "Dream Come True" in Avaya (NYSE: AV). At the time, I thought the $17.50 acquisition price could be bested by a competing bidder and the current acquisition price served as a floor. Since this post the stock has managed to trade off several percentage points but I believe the situation has only become more attractive.

The deal is still expected to close in the fall. Assuming the deal closes December 1st (most likely a very conservative estimate) the current annualized rate of return on the deal is roughly 16% -- a very attractive yield if you believe the deal should go through.

Should you believe in this deal's prospects? In my opinion, the answer to this question is an emphatic yes. Interestingly, two of the company's executives agree as they recently bought $1.4 million of stock going into this deal. As a Wall Street Journal article reports [subscription required] today, insiders rarely buy stock before their company goes private. This buy exemplifies confidence in the deal's prospects from the inside. The buyers -- TPG and Silverlake -- have already arranged financing, according to the WSJ piece.

If the chances of the deal being completed remain good than why would the stock sell-off, you might ask. I think the answer to this question is two-fold. First, nearly every company in the process of an LBO sold off as the credit market showed signs of weakness during the last two months. Additionally, many funds have been cutting their merger arb exposure, likely forcing liquidations in Avaya, among other companies.

Avaya is still a particularly interesting situation. At the current price, you are set to earn a 4-5% absolute rate of return on your money (roughly in-line with Treasuries and CDs). But you would expect to make this in 2-4 months instead of twelve. With the company's executives loading up on shares and the private-equity buyers already having financed the deal, I think the likelihood of this deal being completed remains strong.

Inside of investing there is a culture known as 'arbitrageurs.' While there's many different types of arbitrage, merger arbitrage has become an increasingly-used strategy amongst traders and investors during the last few years. The primary reason: the private equity boom.

Merger arbitrageurs try to purchase stocks after a buyout has been announced but before it has been completed. For example, if a stock is being taken out for $22 per share and is currently trading for $20 per share, the 'arbs' might buy the stock betting that the deal is completed and they can keep their 10% assumed rate of return. Understandably, the increased private equity activity during the last few years has helped to fuel a boom in this strategy.

But the Wall Street Journal's "Heard on the Street" column is reporting [subscription required] that many arbitrageurs are pairing back their exposure to the merger arbitrage space due to losses amounting to more than 2.5% already this month. What's the reason for the weak performance? Simply put, the increased borrowing costs for private equity funds have made many deals unlikely to be completed because they make less sense for private equity investors.