A convertible bond (CB) arbitrage hedge fund manager buys 20 convertible bonds with a PAR Value of $1,000 paying an annual coupon of 3.5%. The CB purchase price was $960 per bond. Each CB is convertible into 10 shares of common stock at $25 per share which is also the current share price. The hedge fund manager has determined that the appropriate hedge ratio is 0.70. The short rebate is 2.5% and borrowing cost is 4.0%. The stock pays an annual dividend of $1 per share. If the manager has entered into the position with a 2-to-1 leverage ratio (i.e., borrow 50% of the capital) and after one year, the price of the bonds jumps to $990 with the stock price at $27, calculate the manager’s return on investment.
Debenture Valuation
A debenture is a private and long-term debt instrument issued by financial, non-financial institutions, governments, or corporations. A debenture is classified as a type of bond, where the instrument carries a fixed rate of interest, commonly known as the ‘coupon rate.’ Debentures are documented in an indenture, clearly specifying the type of debenture, the rate and method of interest computation, and maturity date.
Note Valuation
It is the process to determine the value or worth of an asset, liability, debt of the company. It can be determined by many processes or techniques. Many factors can impact the valuation of an asset, liability, or the company, like:
A convertible bond (CB) arbitrage hedge fund manager buys 20 convertible bonds with a PAR Value of $1,000 paying an annual coupon of 3.5%. The CB purchase price was $960 per bond. Each CB is convertible into 10 shares of common stock at $25 per share which is also the current share price. The hedge fund manager has determined that the appropriate hedge ratio is 0.70. The short rebate is 2.5% and borrowing cost is 4.0%. The stock pays an annual dividend of $1 per share. If the manager has entered into the position with a 2-to-1 leverage ratio (i.e., borrow 50% of the capital) and after one year, the price of the bonds jumps to $990 with the stock price at $27, calculate the manager’s return on investment.
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