Convertible Arbitrage

Minimize risk and maximize profits with convertible arbitrage
Convertible arbitrage involves purchasing a portfolio of convertible securities-generally convertible bonds-and hedging a portion of the equity risk by selling short the underlying common stock. This increasingly popular strategy, which is especially useful during times of market volatility, allows individuals to increase their returns while decreasing their risks. Convertible Arbitrage offers a thorough explanation of this unique investment strategy. Filled with in-depth insights from an expert in the field, this comprehensive guide explores a wide range of convertible topics. Readers will be introduced to a variety of models for convertible analysis, "the Greeks," as well as the full range of hedges, including titled and leveraged hedges, as well as swaps, nontraditional hedges, and option hedging. They will also gain a firm understanding of alternative convertible structures, the use of foreign convertibles in hedging, risk management at the portfolio level, and trading and hedging risks. Convertible Arbitrage eliminates any confusion by clearly differentiating convertible arbitrage strategy from other hedging techniques such as long-short equity, merger and acquisition arbitrage, and fixed-income arbitrage.
Nick Calamos (Naperville, IL) oversees research and portfolio management for Calamos Asset Management, Inc. Since 1983 his experience has centered on convertible securities investment. He received his undergraduate degree in economics from Southern Illinois University and an MS in finance from Northern Illinois University."Convertible Arbitrage" ist ein praxisorientierter und umfassender Ratgeber, der sich mit einer interessanten Investmentstrategie auseinandersetzt - der 'Convertible Arbitrage'.

Bei dieser Strategie geht es darum, ein Portfolio aus wandelbaren Wertpapieren anzulegen - in der Regel Wandelanleihen -, wobei das Risiko teilweise dadurch abgesichert wird, dass die zugrundeliegende Stammaktie leerverkauft wird.

Diese Strategie erfreut sich wachsender Beliebtheit und ist insbesondere in Zeiten hoher Marktvolatilität von Nutzen, denn sie ermöglicht Finanzexperten eine Steigerung der Rendite bei einer Verringerung des Risikos.

"Convertible Arbitrage" erläutert diese einzigartige Investmentstrategie fundiert und detailliert.

Mit einer Fülle von Experten-Informationen.

Autor Nick Calamos ist ein anerkannter Fachmann auf diesem Gebiet. Er ist regelmäßig auf CNBC zu sehen und wird häufig von Fachzeitschriften interviewt.

Chapter 1 Convertible Arbitrage: An Overview 1

Convertible Arbitrage: A Brief History 1

Why Hedge with Convertibles? 6

Convertible Arbitrage Performance 7

What About Risks? 12

Basics of Convertible Securities 15

Risk-Reward Analysis 18

Methods of Valuation 18

Convertible Profile Graph 22

Basics of Convertible Arbitrage 23

Multiple Convertible Structures 26

Appendix 1.1 32

Chapter 2 Valuation 34

Convertible Valuation Models 34

Binomial Option Model 34

Chapter 3 The Greeks 48

Measures of Risk 48

Delta (∆) 48

Gamma (Γ) 51

Vega (v) 55

Theta (ϑ) 57

Rho (ρ) 59

More on Volatility 61

Chi (χ) 64

Omicron (ο) 65

Upsilon (u) 67

Phi (f) 69

Mandatory Convertible Greeks 70

Chapter 4 Credit and Equity Considerations 74

Credit Evaluation 74

Credit Analysis and Equity Market Feedback 76

Asset Value Credit Evaluation 79

Cash Flow and Valuing a Business 85

Business Valuation Model 85

I. Cash Inflows: Capital Employed 87

II. Cash Outflows: Economic Profit 94

III. Cash-Inflow Model 100

IV. Intrinsic Business Value 106

Chapter 5 Convertible Arbitrage Techniques—Delta Hedging 110

Delta Neutral Hedge (Long Volatility) 112

Delta Estimates versus Theoretical Deltas 117

Dynamic Rebalancing of the Delta Neutral Hedge 117

Delta Neutral Hedge on Leverage 120

Delta Hedge—Currency Hedge Overlay 122

Appendix 5.1 128

Appendix 5.2 131

Chapter 6 Gamma Capture Hedging 134

Capturing the Gamma in a Convertible Hedge 134

Bearish Tilt Gamma Convertible Hedge 141

Bearish Gamma Hedge on Leverage 143

The Gamma Tilt Hedge’s Role in a Market Neutral Portfolio 145

Chapter 7 Convertible Option Hedge Techniques 148

Covered or Partially Covered Convertible Call Option Hedge 151

Long Convertible Stock Hedge with Call Write Overlay 154

Synthetic Bond—Long Busted Convertible with Call Write and Long Out-of-the-Money Call for Protection 157

Convertible Stock Hedge—Put Purchase Provides Additional Downside Protection 161

Convertible Hedge Call Write with Protective Long Put 165

Mandatory Convertible Preferred—Stock Hedge with Call Write Overlay 169

Chapter 8 Convertible Asset Swaps and Credit Default Swaps 172

Convertible Asset Swaps—Extracting Cheap Options from Investment-Grade Convertibles 172

The Mechanics of Convertible Asset Swapping 173

Swap Hedge Setup 176

Convertible Bond Credit Default Swap—Transfer Credit Risk in a Hedge 179

Appendix 8.1 185

Chapter 9 Non-traditional Hedges 194

The Reverse Hedge 194

Call Option Hedge: Monetization of a Cheap Embedded Call Option 199

Stock Hedge to Capture Cheap or Free Put Options 200

Convergence Hedges 210

Merger and Acquisition Risk Arbitrage Trades 217

Reset Convertibles (or Death Spiral Convertibles) 218

Capital Structure Hedge 218

Distressed Convertible Hedge or Negative Gamma Hedge Opportunities 220

Basket Hedging Equity Delta 231

Synthetic Worksheet Hedge 234

Dividend Reduction Convertible Hedge 236

Trading Desk Value Added 239

Trade Execution 240

Appendix 9.1 242

Appendix 9.2 244

Take-Over Risks—An Example 244

Chapter 10 Portfolio Risk Management 248

Balance Sheet Leverage 250

Scenario Analysis 252

Hedging Systematic Risks with Index Options 255

Hedging Interest Rate Risk—Yield Curve Shifts 257

Hedging Volatility with Volatility Swaps 258

Hedging Omicron with Volatility Swaps 263

Hedging Omicron with Credit Default Swap Basket or Short Closed End Funds 265

Rough Spots for Convertible Arbitrage 266

Managing the Convertible Arbitrage Manager 271

Glossary 273

Index 289

"...filled with in-depth insights and a wide range of convertible topics, provides a thorough explanation..." (Financial World, January 2004) NICK P. CALAMOS is the Head of Investments and Chief Investment Officer overseeing research and portfolio management for Calamos Asset Management, Inc., one of the largest and most well-known convertible investment firms in the country. He oversees the #1 Convertible Fund and the #1 Growth Fund as rated by Lipper and Morningstar for the ten-year period ended 12/31/02. With the firm since 1983, Mr. Calamos has been instrumental in developing the Calamos Convertible Research System (CCRS), a sophisticated, proprietary research system that monitors and scans the entire market for the best available investment opportunities. A Chartered Financial Analyst (CFA), Mr. Calamos is a member of the Investment Analysts Society of Chicago. He has spoken at various conferences and seminars throughout the country on convertible securities investing, has been quoted as an authority on convertible securities by leading financial publications such as Barron’s, Fortune, The Wall Street Journal, USA Today, and the New York Times, and has appeared on CNBC and Bloomberg television. He received his undergraduate degree in economics from Southern Illinois University and an MS in finance from Northern Illinois University. Investment professionals familiar with convertible arbitrage techniques recognize the strategy as a rock-solid tool for generating significant returns regardless of market movements. It’s no surprise, then, that amidst the backdrop of market volatility and investor uncertainty, the field of convertible arbitrage keeps growing. Since 1993, the convertible arbitrage market has grown at an astounding 45% compound annual growth rate through the first half of 2002 to $24 billion.*

In Convertible Arbitrage: Insights and Techniques for Successful Hedging, renowned investment expert Nick P. Calamos shows you ways to make the most of convertible arbitrage, explaining how to boost returns while decreasing risk–no matter what the market is doing.

The practice of convertible arbitrage takes advantage of the unique hybrid nature of convertible securities, which combine both fixed-income and equity characteristics. It typically involves matching a long position in convertible securities–usually convertible bonds–with a short position of corresponding stock. The bond pays interest and guarantees a yield upon maturity–but you also can participate in the movement of the underlying stock because a convertible bond’s option component makes it readily convertible into stock. Convertible arbitrage thus allows investors to create positions that achieve either market-neutral returns or that have a bias towards a security’s future price, offering tools to both the defensive and aggressive investor.

This not-to-be-missed guide gives you:

• A top-to-bottom overview of convertible arbitrage–its history, how it works, and why it is especially useful in a volatile market
• In-depth coverage of convertible valuation models and the "greeks," the statistical qualifications of convertible functions
• Reasons why the credit and business valuation of a convertible can make or break your hedge position
• A thorough review of convertible arbitrage techniques–from delta hedges and convertible option hedge techniques to swaps and nontraditional hedges
• An insider’s guide to portfolio risk management, including tips on portfolio evaluation, risk analysis, and optimization

The array of convertible securities available–and the ever-shifting financial engineering behind them–demands a practical working knowledge of convertible arbitrage hedging techniques. Not only does Convertible Arbitrage put those techniques at your fingertips, it also helps you use those techniques to prepare for–and profit from–new twists in convertible terms, types of securities, or derivative hedge products.

*Tremont Advisers, Inc.

"The Calamos Convertible Fund offers the Holy Grail in investing–a long-term return superior to the index with less volatility."
–William Harding, Analyst
Morningstar Investment Services

Master convertible arbitrage and put profits within reach

"Finally, we have a comprehensive, practical, and lucid book on convertible arbitrage from one of the most seasoned investors in this growing asset class."
–Venu Krishna, CFA
Head of U.S. Convertible Research, Lehman Brothers

"Nick Calamos is one of the most experienced and successful convertible bond managers in the mutual fund industry. Who better to explain convertible arbitrage strategies?"
—William Harding, Analyst, Morningstar Investment Services

"Convertible Arbitrage is an indispensable resource, and is required reading for all fund of funds analysts and portfolio managers that cover this strategy."
–Joseph G. Nicholas, Chairman and CEO
HFR Asset Management, LLC

In good markets and bad, convertible arbitrage can give investors the best of both worlds: the safety of bonds and all the possibilities of stock-like performance.

This is partly why convertible arbitrage–following the larger trend of hedge funds–has moved to center stage in the last decade. But profiting from this increasingly popular investment strategy takes much more than knowing a few ground rules. It takes Convertible Arbitrage: Insights and Techniques for Successful Hedging.

Written by leading investment authority Nick P. Calamos, this comprehensive, just-in-time book covers:

• What the convertible arbitrage strategy is and what distinguishes it from other hedging techniques
• How to tap into successful convertible valuation models
• The full range of hedges, from tilted and leveraged hedges to swaps and option hedging
• And more!

Nick P. Calamos is the first recipient of the Excellence in Fund Management Award for Calamos Growth and Income Fund, bestowed by S&P and BusinessWeek.