CFA Level IAlternative InvestmentsEasy
Which of the following describes a key characteristic of convertible arbitrage hedge funds?
- AThey take long and short positions in equity securities of companies within the same industry.
- BThey aim to profit from mispricings between a convertible bond and its underlying equity.
- CThey primarily invest in distressed debt and equity of companies facing bankruptcy.
- DThey use quantitative models to identify and exploit short-term price inefficiencies in liquid markets.
Show answer & explanationAnswer & explanation
Correct answer: B. They aim to profit from mispricings between a convertible bond and its underlying equity.
Convertible arbitrage strategies exploit pricing discrepancies between a company's convertible bonds and its common stock, often involving a long position in the convertible bond and a short position in the underlying equity.
Why the other options are wrong
- A. This describes an equity long/short strategy, often within a market neutral framework.
- C. This describes a distressed securities strategy.
- D. This describes a quantitative or systematic trading strategy, which can be applied across various asset classes.
Convertible Arbitrage
A hedge fund strategy that profits from mispricings between convertible bonds and their underlying common stock.
- Typically involves buying the convertible bond and shorting the underlying equity.
- Aims to be market neutral by hedging equity price risk.
- Profits from volatility, credit spread changes, and bond-equity conversion features.
Memory trick: Arbitrage seeks mispricing, Converts link Bond & Stock.