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FRM Part II · FRM Exam Part II · Hedge Fund Investment Strategies

A convertible arbitrage fund holds 1,000 convertible bonds, each convertible into 20 shares. The bond's delta is 0.55. The share price is USD 40. To be delta neutral, how many shares should the fund short, and what is the approximate USD value of the short?

The fund should short 11,000 shares worth USD 440,000. The bonds convert into 20,000 shares, and multiplying by the 0.55 delta gives the hedge ratio. Multiplying 11,000 shares by the USD 40 price gives the short's value.

  1. A11,000 shares; USD 440,000Correct
  2. B20,000 shares; USD 800,000
  3. C11,000 shares; USD 800,000
  4. D36,364 shares; USD 1,454,560

Explanation

Shares underlying = 1,000 x 20 = 20,000. Hedge = 0.55 x 20,000 = 11,000 shares. Value = 11,000 x 40 = USD 440,000. Shorting 20,000 shares ignores delta and over-hedges. Dividing by delta (36,364) is the inversion mistake.

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