FRM Part I · FRM Exam Part I · Fund Management
A hedge fund manager buys convertible bonds of several firms and simultaneously shorts a number of shares of each issuer equal to the bond's delta times the shares into which it converts. Which description best fits this strategy and its main exposure after delta hedging?
This is convertible arbitrage. The manager is long the bond's embedded call option and shorts delta-equivalent stock, leaving a delta-neutral, long-gamma position that gains from large underlying price moves and rebalancing, while credit and liquidity risks remain.
- AConvertible arbitrage, which is long gamma and benefits from large moves in the underlying stock priceCorrect
- BMerger arbitrage, which is short gamma and benefits from deal completion
- CGlobal macro, which is long gamma and depends on currency trends
- DFixed-income arbitrage, which is short gamma and benefits from stable stock prices
Explanation
Convertible arbitrage buys the convertible, whose embedded option gives positive gamma, and shorts stock to neutralize delta. The position profits from realized volatility via rebalancing. Short gamma is the wrong sign for a long option holder.
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