Convertible Bond Arbitrage Returns are composed of what elements?

• A. Only the change in stock price
• B. Bond interest, equity position return, and financing expenses
• C. The actual cost of the bond
• D. Only interest revenue from converted shares

Answer: (B)

Convertible bond arbitrage returns are indeed composed of bond interest, the return from the equity position, and financing expenses.

When engaging in convertible bond arbitrage, an investor typically purchases a convertible bond, which offers the right to convert the bond into a predetermined number of shares of the underlying stock. The investor benefits from the interest payments received from the bond, and the potential appreciation of the stock price adds another layer of return. Additionally, there are financing expenses associated with holding the positions, such as the cost of borrowing funds to finance the purchase of the convertible bonds or the underlying equity.

When the stock price rises, the inherent value of the bond's conversion feature increases, contributing positively to the overall returns. Without considering the bond interest, equity returns, and financing costs, one does not get a complete picture of the returns associated with convertible bond arbitrage.