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. Is there a difference between financial spread betting and arbitrage?

    Financial spread betting is a type of speculation that involves a highly leveraged derivative product, whereas arbitrage ... Read Full Answer >>
  2. Why do companies enter into futures contracts?

    Different types of companies may enter into futures contracts for different purposes. The most common reason is to hedge ... Read Full Answer >>
  3. What are the goals of covered interest arbitrage?

    The goals of covered interest arbitrage include enabling investors to trade volatile currency pairs without risk as well ... Read Full Answer >>
  4. How can I hedge my portfolio to protect from a decline in the food and beverage sector?

    The food and beverage sector exhibits greater volatility than the broader market and tends to suffer larger-than-average ... Read Full Answer >>
  5. What techniques are most useful for hedging exposure to the insurance sector?

    Investing style determines the best hedging techniques for the insurance sector. This sector comprises three segments, two ... Read Full Answer >>
  6. How can I hedge my portfolio to protect from a decline in the retail sector?

    The retail sector provides growth investors with a great opportunity for better-than-average gains during periods of market ... Read Full Answer >>
Related Articles
  1. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  2. Forex Strategies

    How To Avoid Exchange Rate Risk

    What are the best strategies to avoid exchange rate risk when trading?
  3. Active Trading Fundamentals

    Arbitrage Pricing Theory: It's Not Just Fancy Math

    What are the main ideas behind arbitrage pricing theory? We provide a simple explanation of the model and how to use it.
  4. Investing Basics

    Explaining Forward Rate Agreements

    Forward rate agreement (FRA) refers to an interest rate or foreign exchange hedging strategy.
  5. Mutual Funds & ETFs

    Currency-Hedged ETFs: Should You Invest?

    Currency-hedged ETFs offer many more pros than cons when compared to their counterparts, but there is still one big con.
  6. Forex Strategies

    Forex or Stock Trading: Which Works For You?

    Even though the odds favor stock trading, forex trading has several advantages to offer a particular type of investor.
  7. Economics

    4 Ways Airlines Hedge Against Oil

    Understand what a fuel hedge is and why an airline company would want to implement a hedging strategy. Learn about the different fuel hedging strategies.
  8. Options & Futures

    Long on Oil? Hedge Falling Oil Prices with Options

    With no end to the oil slump in sight, here are some risk management strategies using options to protect your oil positions.
  9. Investing Basics

    Understanding Arbitrage Pricing Theory

    Investors use the arbitrage pricing theory to identify an asset that’s incorrectly priced.
  10. Mutual Funds & ETFs

    ETF Analysis: iPath S&P 500 VIX Futures

    Learn more about the iPath S&P 500 Short-Term Futures Exchange Traded Note, the characteristics of VXX and the suitability of the ETN for investors.
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

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!