Does anyone have insight (or speculation) into what strategies Convertible Bond Arb funds are currently employing. Based on the sources that I have talked to, everyone seems to agree that there had been a lot of easy money being made from new issue allocations. I've noticed that the new issue market is currently less than spectacular. I think a recent Host Marriott deal had drawn some excitment, was priced at 99 and ended up trading as low as 97 or 98 right out of the gate. One friend also told me that his Convert fund was almost exclusively short converts. In all my previous readings, this "chinese hedge" was described as a something done from time to time. Is this strategy more common than I assumed? Any insight would be helpful.

I'll answer your questions respectively:There are a multitude of Convert arb strategies employed and no one common type. They can range from structural arb, volatility plays, equity subsitutes, relative value, etc etc etc. However, the most common vanilla postion is long convert short equity.New issues can be very profitable, but you are correct that the current new issue market is not what it used to be. I've made out on about three of every five new issue deals that we've done. Made a little on the Host Marriot deal.Most funds out there are not heavily chinesed. Your assumptions are about right.

Convertible Arbitrage: Insights and Techniques for Successful Hedgingby Nick P. CalamosTo be honest I don't know if there's a chapter specifically dedicated to chinese hedge. Rgds,

Thanks for the reference. I have read it. I actually like the book a lot. Quick question, what does it mean when people say, "Analysts put XYZ convertible 2.07% cheap?"

Well many are the elements in evaluation of cheapness of a cb, so if you find the word ‘cheap’ for cb xyz in an analyst report, it seriously depends on 2 principal factors:- Valuation model used- Market factors that make it feel cheap the deal at issue.First, some analysts consider cb as a synthetic security with 2 parts, a plain bond and an equity warrant, with maturity set at bond first call date. The strike of your warrant is calculated with forward bullet price (example 90.00 bullet price) divided by the conversion ratio. Second step is multiplying warrant premium by conversion ratio. If you use historical volatility of underlying in this way when valuing the warrant (opt) part of your cb you should obtain fair value of the cb issue to be compared with real issue price. A cb is valued as cheap or attractive with issue prices lower than fair prices and there’s an opportunity of buying value. This method is although not complete in fact conversion opt extends itself till maturity and not limited at first call date. In addition there’s a separate valuation on credit risk of issuer. And value you buy in credit spread in bp on t-bonds. Remember to take into consideration ytm and rating.Second, analysts use to read performance of cb at sector level and equity market with delta for single issue although internal performance of convertibles reflects weakness or strength of equity markets, sometimes against a weak market backdrop valuation profile of cb may be deteriorated somewhat. Many global houses use to calculate weighted average premium level and corollary of weighted average premium expansion could be reduction of sensitivity of marketplace, other measure of equity sensitivity is s/iv; or Vega weighted IV. Putting a cb 2.07% cheap means that using your model theoretical value is 102.7 and if issue price is par (100) you could get a 2.07% value. Rgds,

Others have provided very good input. Regarding chinese hedging of deals, it becomes more widespread when the entire convert unvierse gets expensive. For example, I detected it was a popular sub-strategy, last summer when the market encountered overvaluation.

IMHO convertible arb was a buyers market through decades. now the arb funds make up for more than ten percent of convertVolume outstanding. thus the mispriced new issue game is over. and with it the high sharpe ratios. golden convert days are gone. and i suppose that even in good times, success was more a result of few buyers in facing much more sellers than smart modelling.