11/5/2018 Convertible arbitrage - Wikipedia

Convertible arbitrage
Convertible arbitrage is a market-neutral investment strategy often employed by hedge funds. It involves the
simultaneous purchase of convertible securities and the short sale of the same issuer's common stock.

The premise of the strategy is that the convertible is sometimes priced inefficiently relative to the underlying stock, for
reasons that range from illiquidity to market psychology. In particular, the equity option embedded in the convertible
bond may be a source of cheap volatility, which convertible arbitrageurs can then exploit.

The number of shares sold short usually reflects a delta-neutral or market-neutral ratio. As a result, under normal market
conditions, the arbitrageur expects the combined position to be insensitive to small fluctuations in the price of the
underlying stock. However, maintaining a market-neutral position may require rebalancing transactions, a process called
dynamic delta hedging. This rebalancing adds to the return of convertible arbitrage strategies.

Contents
Risks
See also
References
External links

Risks
As with most successful arbitrage strategies, convertible arbitrage has attracted a large number of market participants,
creating intense competition and reducing the effectiveness of the strategy. For example, many convertible arbitrageurs
suffered losses in early 2005 when the credit of General Motors was downgraded at the same time Kirk Kerkorian was
making an offer for GM's stock. Since most arbitrageurs were long GM debt and short the equity, they were hurt on both
sides. Going back a lot further, many such "arbs" sustained big losses in the so-called "crash of '87". In theory, when a
stock declines, the associated convertible bond will decline less, because it is protected by its value as a fixed-income
instrument: it pays interest periodically. In the 1987 stock market crash, however, many convertible bonds declined more
than the stocks into which they were convertible, apparently for liquidity reasons, with the market for the stocks being
much more liquid than the relatively small market for the bonds. Arbitrageurs who relied on the traditional relationship
between stock and bond gained less from their short stock positions than they lost on their long bond positions.

See also
Convertible bond
Convertible security

References

External links
https://en.wikipedia.org/wiki/Convertible_arbitrage 1/2
11/5/2018 Convertible arbitrage - Wikipedia

Hedge Fund Strategy - Convertible Arbitrage (http://www.barclayhedge.com/research/educational-articles/hedge-fund

-strategy-definition/hedge-fund-strategy-convertible-arbitrage.html)

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