Convertible Arbitrage

A convertible bond is an issue or debt obligation conferring a continuous interest rate with the optionality of conversion to an equity position in the company determined by a preset quantity of shares stipulated in the terms of the debenture. Convertible arbitrage entails the simultaneous acquisition and short-selling of a convertible bond and its underlying security according to a fixed ratio ascertained by the delta where delta is the sensitivity of the convertible bond to changes in the underlying security. This arbitrage method implies pricing inefficiencies in the parity of the convertible bond and its underlying security, such as the security price exceeding that of the convertible bond and vice versa where the cheaper may be short-sold and the more expensive acquired.