Convertible Arb

A convertible bond arbitrage portfolio has begun implementing a strategy by purchasing convertible bonds with conversion prices substantially below the conversion value. The current portfolio will:

A) behave most like straight bonds

B) be impossible to hedge given the low delta

C) behave most like underlying equity

Schweser says A.

I believe it would be C because my understanding is Conversion value > conversion price = in the money, behaves like equity? What am I missing?

The conversion value = strike price x conversion ratio

Conversion price = Current stock price x conversion ratio

So, if conversion price < conversion value, it means the embedded call option on equity is out of the money, hence why the portfolio behaves more like straight bonds.

1 Like

Thanks fino, I’m just concerned that throughout the CFA texts there have been inconsitencies between L1-L3.

In previous levels, my understanding was that conversion price was determined at issuance i.e. $100 par, 10 shares, = $10 conversion price (“strike price”), while the conversion value would then be determined by multiplying the current stock price by the conversion ratio.

As discussed in this video…

What am I missing here?

Are they not mixing up the terms conversion price and conversion value?? Please explain.

Yes, there are inconsistencies with how the terms are used in Level 1 & Level 2 versus Level 3. You may want to raise this up with the CFA Curriculum team.