CFA Level I · CFA Level I Exam · Hedge Funds
A hedge fund buys a convertible bond and simultaneously sells short the issuer's common stock in a ratio intended to neutralize equity price exposure. The fund's return is derived mainly from the bond's coupon, the short rebate and gamma trading. This strategy is best described as:
The strategy is convertible bond arbitrage. It is a relative value approach that goes long the convertible and shorts the issuer's stock in a delta-hedged ratio, earning coupon, short rebate and gamma trading profits rather than directional equity returns.
- Aconvertible bond arbitrage.Correct
- Bglobal macro.
- Cevent-driven merger arbitrage.
Explanation
Convertible arbitrage is a relative value strategy that is long the convertible and short the underlying equity, delta hedged. Return comes from coupon income, short interest rebate and trading the option's gamma. Global macro takes directional macro views, and merger arbitrage depends on deal completion.
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