Question
A convertible bond (CB) arbitrage hedge fund manager buys ten convertible bonds with a PAR Value of $1,000 paying an annual coupon of 5.5%. The
A convertible bond (CB) arbitrage hedge fund manager buys ten convertible bonds with a PAR Value of $1,000 paying an annual coupon of 5.5%. The CB purchase price was $950 per bond. Each CB is convertible into 80 shares of common stock at $15 per share. The hedge fund manager has determined that the appropriate hedge ratio is 0.60. The manager has the ability to earn a short rebate of 2.0% on the underlying stock and pays 1.0% on any borrowed funds for the CB purchase. Assume the fund manager shorted the shares at the strike price of $15.
If the manager has entered into the position with a 2-to-1 leverage ratio (i.e., borrow 50% of the capital) and after one year, the price of the bonds jumps to $990 with the stock price at $17, calculate the managers return on investment.
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started