Question
A famous hedge fund manager, namely KG, started his career doing convertible bond arbitrage in his university accommodation. You will now learn and think about
A famous hedge fund manager, namely KG, started his career doing "convertible bond arbitrage" in his university accommodation. You will now learn and think about your own convertible arbitrage strategy to answer the next two questions. Convertible bonds give bondholders the option to exchange each bond for a specified number of stocks of the firm, regardless of the market prices of the securities at the time. The option to convert can be exercised at any time up to maturity. The conversion ratio is the number of stocks for which each bond may be exchanged. Suppose Company A has a convertible bond with a conversion ratio of 20, trading at $900 on the market. The company's stock is trading at $50. There is also a 1% interest you will have to pay for borrowing the securities (either the convertible bond or the stock) from your broker (e.g., if you borrow one share of stocks worth $50, you need to pay your broker $50x1%=$0.5). How can you take advantage of this "convertible bond arbitrage" opportunity?
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