Convertible Bond Arbitrage

AAA

DEFINITION of 'Convertible Bond Arbitrage'

An arbitrage strategy that aims to capitalize on mispricing between a convertible bond and its underlying stock. The strategy is generally market neutral; in other words, the arbitrageur seeks to generate consistent returns with minimal volatility regardless of market direction through a combination of long and short positions in the convertible bond and underlying stock.

INVESTOPEDIA EXPLAINS 'Convertible Bond Arbitrage'

If the convertible bond is cheap or undervalued relative to the underlying stock, the arbitrageur will take a long position in the convertible bond and a simultaneous short position in the stock. Conversely, if the convertible bond is overpriced relative to the underlying stock, the arbitrageur will take a short position in the convertible bond and a simultaneous long position in the underlying stock.

The price of a convertible bond is especially sensitive to changes in interest rates, the price of the underlying stock, and the issuer's credit rating. Therefore, another type of convertible bond arbitrage involves buying a convertible bond and hedging two of the three factors so as to get exposure to the third factor at an attractive price.

RELATED TERMS
  1. Credit Rating

    An assessment of the credit worthiness of a borrower in general ...
  2. Municipal Bond Arbitrage

    A strategy that consists of building a portfolio of tax-exempt ...
  3. Maintenance Bond

    A type of surety bond purchased by a contractor that protects ...
  4. Busted Convertible Security

    A convertible security that is trading well below its conversion ...
  5. Conversion Ratio

    The number of common shares received at the time of conversion ...
  6. Conversion Price

    The price per share at which a convertible security, such as ...
RELATED FAQS
  1. What is the difference between convertible and reverse convertible bonds?

    The difference between a regular convertible bond and a reverse convertible bond is the options attached to the bond. While ... Read Full Answer >>
  2. Where does the stock come from when convertible bonds are converted to stock?

    First, let's define convertible bonds. A unique combination of debt and equity, they provide investors with the chance to ... Read Full Answer >>
  3. How valuable is the forward rate as an overall economic indicator?

    Any given forward rate is theoretically equal to its corresponding spot rate plus future expectations. Many investors and ... Read Full Answer >>
  4. How does a merger affect the shareholders?

    A merger affects the shareholders of both companies in different ways and is influenced by several factors, including the ... Read Full Answer >>
  5. How do I find positive correlation in the stock market?

    Positive correlation refers to a statistical relationship in which two variables generally move in the same direction together. ... Read Full Answer >>
  6. Is there a way to profit from arbitrage trades on delivery duty paid?

    It is not possible to profit on Delivery Duty Paid (DDP) in arbitrage trades since DDP is not bought and sold; it is just ... Read Full Answer >>
Related Articles
  1. Bonds & Fixed Income

    Convertible Bonds: Pros And Cons For Companies And Investors

    Find out why businesses choose this type of financing and what effect this has on investors.
  2. Bonds & Fixed Income

    Convertible Bonds: An Introduction

    Find out about the nuts and bolts, pros and cons of investing in bonds.
  3. Options & Futures

    How & Why Interest Rates Affect Options

    The Fed is expected to change interest rates soon. We explain how a change in interest rates impacts option valuations.
  4. Economics

    Arbitrage Strategies With Changing Interest Rates

    Changes in interest rates can give rise to arbitrage opportunities that, while short-lived, can be very lucrative for traders who capitalize on them.
  5. Options & Futures

    Arbitrage Strategies With Binary Options

    Looking for arbitrage opportunities in Binary Options? Here are the ways to encash on those, with the opportunities, risks and limitations.
  6. Investing

    Why Is Arbitrage Trading Legal?

    Not only is arbitrage legal in the US and most developed countries, it can be beneficial to the overall health of a market.
  7. Mutual Funds & ETFs

    How ETF Arbitrage Works

    ETF arbitrage brings the market price of ETFs back in line with net asset values when divergence happens. But how does ETF arbitrage work?
  8. Trading Strategies

    How To Arbitrage Precious Metals

    Here are the fine points, trading tips, suitable securities, and examples for precious metal arbitrage trading.
  9. Brokers

    Arbitrage Opportunities in Spread Betting

    While the opportunities are few and far between, investors may use arbitrage to take advantage of price differences in financial spread betting.
  10. Credit & Loans

    Credit Card Arbitrage: Free Money Or Dangerous Gamble?

    Credit card arbitrage is a way to make some money, but it's a major gamble with devastating risks.

You May Also Like

Hot Definitions
  1. Yield Curve

    A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity ...
  2. Productivity

    An economic measure of output per unit of input. Inputs include labor and capital, while output is typically measured in ...
  3. Variance

    The spread between numbers in a data set, measuring Variance is calculated by taking the differences between each number ...
  4. Terminal Value - TV

    The value of a bond at maturity, or of an asset at a specified, future valuation date, taking into account factors such as ...
  5. Rule Of 70

    A way to estimate the number of years it takes for a certain variable to double. The rule of 70 states that in order to estimate ...
  6. Risk Premium

    The return in excess of the risk-free rate of return that an investment is expected to yield. An asset's risk premium is ...
Trading Center