Legal Definitions - convertible arbitrage

Convertible arbitrage is a type of arbitrage where an investor buys a security that can be exchanged or converted to another security within a reasonable time, while simultaneously selling the second security. The goal is to profit from the price difference between the two securities.

Let's say an investor buys a convertible bond from Company A that can be converted to Company A's stock within a year. At the same time, the investor sells short Company A's stock. If the price of Company A's stock goes up, the investor can convert the bond to stock and sell it at a higher price, while buying back the shorted stock at a lower price to cover the position. The difference between the two prices is the profit.

This example illustrates how convertible arbitrage works. By taking advantage of the price difference between the convertible bond and the underlying stock, the investor can make a profit without taking on too much risk.