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convertible arbitrage strategiesoThese investors typically purchase the convertible and simultaneously sell short acertain number of the issuers common shares that underlie the convertibleoThe number of shares they sell short as a percent of the shares underlying the convertible is approximately equal to the risk neutral probability at that point in time that the investor will eventually convert the security into common sharesoThis probability is then applied to the number of common shares the convertible security could convert into to determine the number of shares the hedge fund investor should sell short (the hedge ratio) oVolatility risk Example
Company’s share price is $10 at the time of its convertible issuance. A hedge fund purchases a portion of the convertible, which gives the right to convert into 100 common shares of the issuerIf the hedge ratio is 65%, the hedge fund may sell short 65 shares of the issuers stock on the same date as the convertible purchaseDuring the life span of the convertible, the hedge fund investor may sell more shares short or buy shares, based on the changing hedge ratioTo illustrate, if one month after purchasing the convertible, the issuers share price decreases to $9, the hedge ratio may drop from 65% to 60%To align the hedge ratio with the shares sold short as a percent of shares, the investor has the right to convert the security into, the hedge fund investor will need to buy five shares in the open market from other shareholders and deliver those shares to the parties who had lent the share originally Covering five shares of their short position leaves the hedge fund with a new short position of 60 sharesIf the issuers share price two months after issuance increases to $11 the hedge ratio may increase to 70%The investor achieves this position by borrowing 10 more shares and selling them short, which increases the short position from 60shares to 70 sharesThis process of buying low and selling high continues until the convertibleeither converts or maturesNikkei Put WarrantsoOne question high level on the Nikkei Put WarrantsAccelerated Share Repurchase Program (ASR)oCompanies need to raise financing and so issue securitiesoCompanies need to reduce cash on balance sheet so repurchase shares back (which goes into the treasury stock) – benefits EPS, employee optionso10(b)5 limits share repurchases to less than or equal to 25% of ADTV (average daily trading volume) Eg. IBMFinal ExamEasy calculations (3-4)Case questionsChapter questionsToo big to failClass stuff