CFA Level I · CFA Level I Exam · Hedge Funds
A hedge fund buys a company's convertible bond and shorts a number of shares equal to the bond's delta times the conversion ratio. As the stock price rises, the fund most likely must:
The fund must sell additional shares short. Rising stock prices increase the convertible's delta, so a larger short position is needed to stay hedged. Selling high and buying back low as prices move is how the fund captures gamma profits.
- Asell additional shares short to maintain the hedge.Correct
- Bbuy back shares previously sold short.
- Cclose the bond position to avoid dividends.
Explanation
A convertible's delta rises as the stock price rises, so the required short hedge grows. The fund sells more shares, and buys back when price falls, which generates gamma trading profits. Buying back shares would be the response to a price decline.
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