Dear all,
Schweser B4, pg 30
Under convertible abitrage strategy: last sentence
‘If the yield curive is upward sloping, making the yeild on the bond higher than ST borrowing rates, the strategy might also be leveraged to enhanced returns’.
Can anyone please explain how the above statement works?
Thank you
if your borrowing rate is lower - borrow more, invest more in the bonds - you get an advantage from the higher yields on the bond you are buying. You have higher returns as well manifested due to the leverage used on your portfolio. (due in part to the higher amount invested on the portfolio with the leverage piece, and also the lower interest rates (difference between the yield on bond and the interest rate paid out on your borrowed amount) adds to the returns.
If you’re shorting the stock and buying bonds, if short-term interest rates are low you can short more stock, buy more bonds, and pay the additional borrowing costs from the yield on the bonds.