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. Conversion Price

    The price per share at which a convertible security, such as ...
  5. Convertible Bond

    A bond that can be converted into a predetermined amount of the ...
  6. Busted Convertible Security

    A convertible security that is trading well below its conversion ...
Related Articles
  1. Convertible Bonds: Pros And Cons For ...
    Bonds & Fixed Income

    Convertible Bonds: Pros And Cons For ...

  2. Convertible Bonds: An Introduction
    Bonds & Fixed Income

    Convertible Bonds: An Introduction

  3. What is the difference between convertible ...
    Options & Futures

    What is the difference between convertible ...

  4. Where does the stock come from when ...
    Investing

    Where does the stock come from when ...

comments powered by Disqus
Hot Definitions
  1. Elasticity

    A measure of a variable's sensitivity to a change in another variable. In economics, elasticity refers the degree to which ...
  2. Tangible Common Equity - TCE

    A measure of a company's capital, which is used to evaluate a financial institution's ability to deal with potential losses. ...
  3. Yield To Maturity (YTM)

    The rate of return anticipated on a bond if held until the maturity date. YTM is considered a long-term bond yield expressed ...
  4. Net Present Value Of Growth Opportunities - NPVGO

    A calculation of the net present value of all future cash flows involved with an additional acquisition, or potential acquisition. ...
  5. Gresham's Law

    A monetary principle stating that "bad money drives out good." In currency valuation, Gresham's Law states that if a new ...
  6. Limit-On-Open Order - LOO

    A type of limit order to buy or sell shares at the market open if the market price meets the limit condition. This type of ...
Trading Center