What is a Chinese hedge?

By Justin Bynum AAA
A:

A Chinese Hedge is a form of arbitrage by which an investor shorts a convertible bond and buys the underlying common stock. The inverse of a Set-Up Hedge, a Chinese Hedge is a bet that a stock's price will rise, taking the value of the convertible bond up with it but reducing the conversion premium associated with the convertible (the price of a convertible bond is tied closely with the underlying stock's price).

When a stock's price is low, the convertible's price is also low, but the premium over and above the actual conversion ratio is high because of the potential for price appreciation. As the stock's price rises, so does the convertible (making the conversion premium less attractive, because the potential for price appreciation is lessened). Depending on the convertible bond's interest rate, a Chinese Hedge may be a very low cost/low risk way of participating in a stock's price appreciation. (For more on this, read A Beginner's Guide to Hedging)

RELATED FAQS

  1. How attractive is the internet sector for a growth investor?

    Learn why the Internet sector is an attractive option for growth investors, as well as what many of them do to reduce the ...
  2. What trading strategies help investors withstand a drawdown?

    Understand the concept of drawdown and the importance for traders of having a trading strategy that takes temporary drawdown ...
  3. Why should investors be concerned with risk management?

    Learn what risk management is, the difference between systematic and unsystematic risk, and why investors should be concerned ...
  4. How do I determine what the right situation is to make a covered call?

    Learn what a covered call is, how to use a covered call strategy, and what situations to sell a call option against a long ...
RELATED TERMS
  1. Hedge Fund

    An aggressively managed portfolio of investments that uses leveraged, ...
  2. Credit Card Arbitrage

    Borrowing money at a low interest rate from a credit card then ...
  3. Cash-And-Carry Trade

    A trading strategy in which an investor buys a long position ...
  4. Money Market Hedge

    A practice that businesses engaging in foreign trade use to eliminate ...
  5. Netting

    Consolidating the value of two or more transactions, payments, ...
  6. Exposure Netting

    A method of hedging currency risk by offsetting exposure in one ...

You May Also Like

Related Articles
  1. Technical Indicators

    Strategies To Trade Volatility Effectively ...

  2. Mutual Funds & ETFs

    Are These the Top Inverse ETFs of 2 ...

  3. Stock Analysis

    How Are Interest Rates Affecting Annaly ...

  4. Trading Strategies

    How To Arbitrage Precious Metals

  5. Mutual Funds & ETFs

    A Guide to Using Inverse ETFs for Diversification

Trading Center