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.

BREAKING DOWN '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. Convertible Arbitrage

    A trading strategy that typically involves taking a long strategy ...
  2. Convertible Bond

    A bond that can be converted into a predetermined amount of the ...
  3. Convertible Hedge

    A trading strategy that consists of a long position in a company's ...
  4. Revertible

    Refers to a special kind of convertible corporate bond that automatically ...
  5. Contingent Convertibles - CoCos

    A security similar to a traditional convertible bond in that ...
  6. Convertible Security

    An investment that can be changed into another form. The most ...
Related Articles
  1. Financial Advisor

    Is Now the Time for Convertible Bonds?

    Convertible bonds offer a competitive rate of return in what is a very tough market right now. Here's how they work.
  2. Investing

    An Introduction to Convertible Bonds

    Getting caught up in all the details and intricacies of convertible bonds can make them appear more complex then they really are.
  3. Investing

    3 Best High-Yielding Convertible Bond ETFs (CWB, ICVT)

    Discover how convertible bond ETFs can offer investors growth and income while hedging fixed income portfolios in a rising rate environment.
  4. Investing

    Why Include Convertible Securities in Your Portfolio

    What are convertible securities and why you should include them in your portfolio.
  5. Investing

    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.
  6. Investing

    The Top 3 Convertible Bond ETFs for 2016 (CWB, ICVT)

    Obtain detailed information on the exchange-traded funds (ETFs) available for traders seeking ETF exposure to convertible bond investments.
  7. Investing

    Can a Bond ETF Work in a Rising Rate Environment?

    The CWB Convertible Securities ETF could be the perfect solution for a rising rate environment.
  8. Investing

    Convertible Bonds

    A convertible bond is a bond the investor can exchange for a specific amount of company stock at a later date. It combines a bond and a call option. The bondholder can benefit if there's an increase ...
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 Answer >>
  2. Do convertible bonds have voting rights?

    Convertible bonds usually have no voting rights until they are converted. Even after conversion, they may not be granted ... Read Answer >>
  3. How do I use a premium put convertible?

    Holders of convertible bonds face all the pitfalls that traditional bondholders face - liquidity risk, interest rate risk ... Read Answer >>
  4. What is the difference between arbitrage and speculation?

    Arbitrage and speculation are very different strategies. Arbitrage involves the simultaneous buying and selling of an asset ... Read Answer >>
Hot Definitions
  1. Liquid Asset

    An asset that can be converted into cash quickly and with minimal impact to the price received. Liquid assets are generally ...
  2. Nostro Account

    A bank account held in a foreign country by a domestic bank, denominated in the currency of that country. Nostro accounts ...
  3. Retirement Planning

    Retirement planning is the process of determining retirement income goals and the actions and decisions necessary to achieve ...
  4. Drawdown

    The peak-to-trough decline during a specific record period of an investment, fund or commodity. A drawdown is usually quoted ...
  5. Inverse Transaction

    A transaction that can cancel out a forward contract that has the same value date.
  6. Redemption

    The return of an investor's principal in a fixed income security, such as a preferred stock or bond; or the sale of units ...
Trading Center