Convertible Bond Arbitrage

Convertible bond arbitrage is a business of lending money to corporations in the form of convertible debt and collateralizing that loan with common stock. Convertibles are ideal securities for arbitrage. It is because the convertible itself, namely the underlying stock and the associated derivatives, are traded along predictable ratios and any discrepancy or misprice would give rise to arbitrage opportunities for hedge fund managers. Majority of convertible bond arbitrage deals are constructed with a long position on the convertible bond, hedged with a concurrent short sale of the underlying common stock. This chapter indicates that convertible bond arbitrage is an example of a non-directional strategy whose return is not correlated to capital markets; however, it depends on the fund manager's ability to capture and take benefit of directional spreads.