An arbitrage strategy that aims to capitalize on mispricing between a convertible bond and its underlying stock. The strategy is generally market neutral; in other words, the arbitrageur seeks to generate consistent returns with minimal volatility regardless of market direction through a combination of long and short positions in the convertible bond and underlying stock. |||If the convertible bond is cheap or undervalued relative to the underlying stock, the arbitrageur will take a long position in the convertible bond and a simultaneous short position in the stock. Conversely, if the convertible bond is overpriced relative to the underlying stock, the arbitrageur will take a short position in the convertible bond and a simultaneous long position in the underlying stock. The price of a convertible bond is especially sensitive to changes in interest rates, the price of the underlying stock, and the issuer's credit rating. Therefore, another type of convertible bond arbitrage involves buying a convertible bond and hedging two of the three factors so as to get exposure to the third factor at an attractive price.
An investing strategy that involves the long position on a convertible security and a short position in its converting common stock. |||This strategy attempts to exploit profits when there is a pricing error made in the conversion factor of the convertible security.
A preferred, floating rate issue, whose interest rate is tied to Treasury security rates. They can be exchanged for common stock or cash after the next period's dividend rates are announced. The shares received upon conversion are equal in market value to the par value of the preferred. |||The convertible feature is designed to protect the preferred investor's principal and provide greater liquidity in case the issuer's credit rating declines.
The exchange of a convertible type of asset into another type of asset, usually at a predetermined price, on or before a predetermined date. The conversion feature is a financial derivative instrument that is valued separately from the underlying security. Therefore, an embedded conversion feature adds to the overall value of the security. |||An example of an asset that can undergo conversion is a convertible bond. This type of bond gives the bondholder the option to exchange the bond for a predetermined amount of the bond issuer's equity. Typically, the bondholder will exercise the option when the total value of the shares received from conversion exceeds the bond's worth.For example, John owns a convertible bond worth $1,000 from XYZ Corp. If the bond can be converted into 100 shares of XYZ, John will most likely exercise the conversion option only when XYZ's share price exceeds $10.
The number of common shares received at the time of conversion for each convertible security. It is calculated by using this formula: |||The higher the ratio, the higher the number of common shares exchanged per convertible security. The conversion ratio is determined at the time the convertible security is issued and will have an impact on the relative price of the security.
A short-term debt security (note), that can be changed into common stock (convertible) and ranks below other loans (subordinate). |||Don't let all the words in this term intimidate you. Break up the term and it's easy to see this is just a short term bond that has the conditions of being 1) convertible to stock, and 2) subordinate to other debt. This is a common type of debt that companies issue.
A type of loan issued by a company that can be converted into stock by the holder and, under certain circumstances, the issuer of the bond. By adding the convertibility option the issuer pays a lower interest rate on the loan compared to if there was no option to convert. These instruments are used by companies to obtain the capital they need to grow or maintain the business. |||Convertible debentures are different from convertible bonds because debentures are unsecured; in the event of bankruptcy the debentures would be paid after other fixed income holders. The convertible feature is factored into the calculation of the diluted per-share metrics as if the debentures had been converted. Therefore, a higher share count reduces metrics such as earnings per share, which is referred to as dilution.
A method of calculation used to calculate the yield on bonds with maturities of less than one year and which normally sell at a discount and do not pay coupons.Formula |||For example, the CEY calculation allows bond investors to compare the return on a 180-day Treasury bill to a one-year coupon paying bond, to evaluate which instrument will give the investor a higher return.
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