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. What is arbitrage?

    Arbitrage is basically buying in one market and simultaneously selling in another, profiting from a temporary difference. ... Read Answer >>
  2. What is a derivative?

    A derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset, ... Read Answer >>
  3. Is there a difference between financial spread betting and arbitrage? (AAPL, NFLX)

    Find out more about financial spread betting, arbitrage and the differences between financial spread betting and the arbitrage ... Read Answer >>
  4. Why do companies enter into futures contracts?

    Learn how companies use futures contracts for the purposes of hedging their exposure to price fluctuations as well as for ... Read Answer >>
  5. What are the goals of covered interest arbitrage?

    Learn the three major goals of covered interest arbitrage and increase your comprehension of the foreign exchange trading ... Read Answer >>
  6. How can I hedge my portfolio to protect from a decline in the food and beverage sector?

    Learn why countercyclical investments, such as precious metals, serve as the best hedge against exposure to the food and ... Read Answer >>
Related Articles
  1. Sectors

    Bengal Energy Relies on Hedging Amid Volatile Oil Prices (BNGLF)

    Learn about Bengal's business, its energy price exposures and how its hedging program supports its liquidity in an environment of depressed oil prices.
  2. Forex Education

    4 Reasons Currency Hedging is Important

    Learn how currency hedging can help reduce exchange rate risk for a portfolio of foreign stocks. Consider the cost of hedging and its potential benefits.
  3. Options & Futures

    What is a Hedge?

    A hedge investment offsets the risk of adverse price movements in another investment.
  4. Mutual Funds & ETFs

    The 6 Best Alternative Strategies in a Rising Rate Environment (HYHG, TBF)

    Discover six of the best alternative investments that can either help you hedge against or take advantage of rising interest rates.
  5. Fundamental Analysis

    How to Invest Your Excess Cash in Exotic Derivatives (QAI, SPXL)

    Learn whether hedged or leveraged ETFs are right for your portfolio. Discover the factors that should be considered before buying exotic derivatives.
  6. Trading Strategies

    How Risky Is A Short Sale?

    Short selling has many risks that make it unsuitable for a novice investor.
  7. Fundamental Analysis

    The 4 Best Hedges for a Drop in the S&P 500

    Learn about the most effective S&P 500 hedging strategies available to protect a portfolio during steep corrections and long-term bear markets.
  8. Investing Basics

    Common Sense Strategies For Adverse Markets

    Adverse markets require skillful adjustments to reduce risk and find new profit opportunities.
  9. Term

    A Beginner's Guide To Hedging

    Hedging is a practice every investor should know about.
  10. Savings

    How to Invest Your Excess Cash in Commodities ETFs

    Discover how commodity-based ETF investments can help diversify your investment portfolio.
RELATED TERMS
  1. Hedge

    Making an investment to reduce the risk of adverse price movements ...
  2. Hedge Fund

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

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

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

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

    Consolidating the value of two or more transactions, payments, ...

You May Also Like

Hot Definitions
  1. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  2. Society for Worldwide Interbank Financial Telecommunications ...

    A member-owned cooperative that provides safe and secure financial transactions for its members. Established in 1973, the ...
  3. Generally Accepted Accounting Principles - GAAP

    The common set of accounting principles, standards and procedures that companies use to compile their financial statements. ...
  4. DuPont Analysis

    A method of performance measurement that was started by the DuPont Corporation in the 1920s. With this method, assets are ...
  5. Call Option

    An agreement that gives an investor the right (but not the obligation) to buy a stock, bond, commodity, or other instrument ...
  6. Economies Of Scale

    Economies of scale is the cost advantage that arises with increased output of a product. Economies of scale arise because ...
Trading Center