Convertible Arbitrage E-Book

Nick P. Calamos

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Wiley Finance Editions
• Sprache: Englisch

Seitenzahl: 402

Veröffentlichungsjahr: 2011

Beschreibung

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.

Leseprobe

Table of Contents

Title Page

Copyright Page

Dedication

Acknowledgments

CHAPTER 1 - Conveertible Arbitrage: An Overview

CONVERTIBLE ARBITRAGE: A BRIEF HISTORY

WHY HEDGE WITH CONVERTIBLES?

CONVERTIBLE ARBITRAGE PERFORMANE

WHAT ABOUT RISKS?

BASICS OF CONVERTIBLE SECURITIES

RISK-REWARD ANALYSIS

METHODS OF VALUATION

CONVERTIBLE PROFILE GRAPH

BASICS OF CONVERTIBLE ARBITRAGE

MULTIPLE CONVERTIBLE STRUCTURES

APPENDIX 1.1 Return Statistics and Correlation Matrix to Other Hedge ...

CHAPTER 2 - Valuation

CONVERTIBLE VALUATION MODELS

BINOMIAL OPTION MODEL

CHAPTER 3 - The Greeks

MEASURES OF RISK

DELTA (Δ)

GAMMA (Γ)

VEGA (v)

THETA (ϑ)

RHO (ρ)

MORE ON VOLATILITY

CHI (χ)

OMICRON (0)

UPSILON (υ)

PHI (φ)

MANDATORY CONVERTIBLE GREEKS

CHAPTER 4 - Credit and Equity Considerations

CREDIT EVALUATION

CREDIT ANALYSIS AND EQUITY MARKET FEEDBACK

ASSET VALUE CREDIT EVALUATION

CASH FLOW AND VALUING A BUSINESS

BUSINESS VALUATION MODEL

I. CASH INFLOWS: CAPITAL EMPLOYED

II. CASH OUTFLOWS: ECONOMIC PROFIT

III. CASH-INFLOW MODEL

IV. INTRINSIC BUSINESS VALUE

CHAPTER 5 - Convertible Arbitrage Techniques—Delta Hedging

DELTA NEUTRAL HEDGE (LONG VOLATILITY)

DELTA ESTIMATES VERSUS THEORETICAL DELTAS

DYNAMIC REBALANCING OF THE DELTA NEUTRAL HEDGE

DELTA NEUTRAL HEDGE ON LEVERAGE

DELTA HEDGE—CURRENCY HEDGE OVERLAY

APPENDIX 5.1

APPENDIX 5.2 General Rules and Regulations Promulgated under the Securities ...

CHAPTER 6 - Gamma Capture Hedging

CAPTURING THE GAMMA IN A CONVERTIBLE HEDGE

BEARISH TILT GAMMA CONVERTIBLE HEDGE

BEARISH GAMMA HEDGE ON LEVERAGE

THE GAMMA TILT HEDGE’S ROLE IN A MARKET NEUTRAL PORTFOLIO

CHAPTER 7 - Convertible Option Hedge Techniques

COVERED OR PARTIALLY COVERED CONVERTIBLE CALL OPTION HEDGE

LONG CONVERTIBLE STOCK HEDGE WITH CALL WRITE OVERLAY

SYNTHETIC BOND—LONG BUSTED CONVERTIBLE WITH CALL WRITE AND LONG ...

CONVERTIBLE STOCK HEDGE—PUT PURCHASE PROVIDES ADDITIONAL DOWNSIDE PROTECTION

CONVERTIBLE HEDGE CALL WRITE WITH PROTECTIVE LONG PUT

MANDATORY CONVERTIBLE PREFERRED—STOCK HEDGE WITH CALL WRITE OVERLAY

CHAPTER 8 - Convertible Asset Swaps and Credit Default Swaps

CONVERTIBLE ASSET SWAPS—EXTRACTING CHEAP OPTIONS FROM INVESTMENT-GRADE CONVERTIBLES

THE MECHANICS OF CONVERTIBLE ASSET SWAPPING

SWAP HEDGE SETUP

CONVERTIBLE BOND CREDIT DEFAULT SWAP—TRANSFER CREDIT RISK IN A HEDGE

APPENDIX 8.1 ASSET SWAP AND CREDIT DEFAULT SWAP TERM SHEETS

CHAPTER 9 - Non-traditional Hedges

THE REVERSE HEDGE

CALL OPTION HEDGE: MONETIZATION OF A CHEAP EMBEDDED CALL OPTION

STOCK HEDGE TO CAPTURE CHEAP OR FREE PUT OPTIONS

CONVERGENCE HEDGES

MERGER AND ACQUISITION RISK ARBITRAGE TRADES

RESET CONVERTIBLES (OR DEATH SPIRAL CONVERTIBLES)

CAPITAL STRUCTURE HEDGE

DISTRESSED CONVERTIBLE HEDGE OR NEGATIVE GAMMA HEDGE OPPORTUNITIES

BASKET HEDGING EQUITY DELTA

SYNTHETIC WORKSHEET HEDGE

DIVIDEND REDUCTION CONVERTIBLE HEDGE

TRADING DESK VALUE ADDED

TRADE EXECUTION

APPENDIX 9.1 PARTIAL LISTING OF COMPANIES WITH MULTIPLE CONVERTIBLE ISSUES ...

APPENDIX 9.2 CONVERTIBLE ARBITRAGE TAKE-OVER RISKS

TAKE-OVER RISKS—AN EXAMPLE

CHAPTER 10 - Portfolio Risk Management

BALANCE SHEET LEVERAGE

SCENARIO ANALYSIS

HEDGING SYSTEMATIC RISKS WITH INDEX OPTIONS

HEDGING INTEREST RATE RISK—YIELD CURVE SHIFTS

HEDGING VOLATILITY WITH VOLATILITY SWAPS

HEDGING OMICRON WITH VOLATILITY SWAPS

HEDGING OMICRON WITH CREDIT DEFAULT SWAP BASKET OR SHORT CLOSED END FUNDS

ROUGH SPOTS FOR CONVERTIBLE ARBITRAGE

MANAGING THE CONVERTIBLE ARBITRAGE MANAGER

Glossary

Index

Copyright © 2003 by Nick P. Calamos. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey Published simultaneously in Canada

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Library of Congress Cataloging-in-Publication Data

Calamos, Nick, P. 1961−

Convertible arbitrage: insights and techniques for successful hedging/Nick P. Calamos. p. cm.—(Wiley finance series)

Includes index.

ISBN 0-471-42361-0 (CLOTH)

1. Hedging (Finance) 2. Arbitrage. I. Title. II. Series.

HG6024.A3C345 2003

332.64’5—dc21

2003000580

To my wife Kim, my parents Joan and Angelo, and my children, Zach, Katie, Kristie, and Cole

Acknowledgments

This book’s target audience includes beginner and intermediate convertible specialists, hedge fund consultants, and convertible securities traders. It should also be a useful handbook for retirement and endowment plan sponsors that invest in hedge funds and individual investors who would like to understand more about what their convertible hedge manager is doing and what the risks may be.

I want to thank John Calamos, Sr. for the opportunity he provided me 20 years ago to join Calamos Asset Management, which was then a small specialist convertible securities investment shop managing $35 million in client assets. Today, the firm has grown to become Calamos Investments, one of the largest convertible managers in the country as well as a respected growth-equity, convertible-arbitrage, and high-yield manager with more than $13 billion in assets under management. Over the years John has been a mentor and consultant to me in business as well as in my personal life. He has offered me many opportunities and challenges to grow professionally and his commitment to constant improvement and lifetime learning has been an example that I hope to pass on to my children. Put simply, John’s guidance has been instrumental in my career and provided the foundation for this book.

I also want to thank my wife Kim, as in all things over the past 22 years, for her love, patience, and support during the many weekends, evenings, and vacations spent in my office writing this book.

A number of colleagues at Calamos Investments have had a hand in the completion of this book. I want to thank Jeff Kelley who spent many hours editing and improving my rough draft. His hard work and talent allowed this book to progress quickly and provided much better flow than would otherwise have been the case. I also want to thank Marilyn Dale, who coordinated most of the communication and scheduling with the publisher, and kept me on schedule. Finally, I want to thank Tony Onorati and Chris Hartman who helped with many of the graphs and charts in the book and Jeff Scudieri who reviewed drafts and provided valuable feedback.

CHAPTER 1

Conveertible Arbitrage: An Overview

There was a time when the word “arbitrage” brought to mind apicture of a mysterious realm in finance which few people seemedto be inclined or at least to have the knowledge to discuss. I knewin a general way that profits depended upon price differences, butI believed that it was with lightning speed at a nerve-racking pacethat computations, purchases, and sales must be executed in orderto reap a profit.

—Meyer H. Weinstein, Arbitrage in Securities

CONVERTIBLE ARBITRAGE: A BRIEF HISTORY

The practice of convertible arbitrage includes the traditional purchase of a convertible while shorting its underlying stock, but also includes warrant hedging, reverse hedging, capital structure arbitrage, and various other techniques that exploit the unique nature of the global convertible and warrant marketplace. While the quantitative modeling, arcane mathematics, and hedge fund strategies affiliated with such techniques may make the practice seem a symbol of the latest in financial innovation, it has actually been around for more than a century, practically since the launch of convertible securities. Convertible securities came into being as a way to make securities more attractive to investors. Convertible bonds are not new; issuers and investors have been using them since the 1800s. During the nineteenth century, the United States was what we would now classify as an emerging market. It was not easy to gain access to capital in a rapidly growing country. The convertible clause was added first to mortgage bonds to entice investors to finance the building of the railroads. The Chicago, Milwaukee & St. Paul Railway, for example, used many convertible issues for financing between 1860 and 1880. In 1896, that company had 12 separate convertible issues outstanding, most bearing a 7 percent coupon.

Convertible securities are relatively simple in concept: A convertible bond is a regular corporate bond that has the added feature of being converted into a fixed number of shares of common stock. Conversion terms and conditions are defined by the issuing corporation at issuance. (A convertible security may also be preferred stock, but convertibles are best understood by studying convertible bonds.) The actual terms can vary significantly, but the traditional convertible bond pays a fixed interest rate and has a fixed maturity date. The issuing company guarantees to pay the specified coupon interest, usually semiannually, and the par value, usually $1,000 per bond, upon maturity. Like other nonconvertible bonds, a corporation’s failure to pay interest or principal when due results in the first step toward company bankruptcy. Therefore, convertible bonds share with nonconvertible bonds the feature that bond investors consider most precious: principal protection. Convertibles are senior to common stock but may be junior to other long-term debt instruments. Convertibles have one important feature that other corporate bonds do not have: At the holder’s option, the bond can be exchanged for the underlying common stock of the company. This feature completely changes the investment characteristics of the bond, and is one of the characteristics that make convertible arbitrage possible.