Question 1 [30 points] Please provide concise/brief answers to the following que

Question

Question 1 [30 points]
Please provide concise/brief answers to the following questions
a. [6] What is a convertible bond? Based on the definition you provided, what
are the risks of a convertible bond arbitrage strategy?
b. [6] Mention and briefly explain the data risks in reported hedge fund
performance. Would these risks create an upward or downward bias?
c. [6] One of the distinguishing features of a hedge fund is shorting of securities;
how does shorting work? What are some other distinguishing features?
d. [6] Why are corporate restructuring strategies like selling a put option? What
does this imply for the distribution of returns in terms of skewness and
kurtosis?
e. [6] What is meant by the typical 2/20 compensation scheme of a hedge fund?
Use the ‘free option’ theory to argue why this induces risk taking

Explanation / Answer

a.

Convertible bond: The issued-bond which can be converted into equity stock after certain period is known as convertible bond.

Risk: Convertible bond has to be held for certain period of time before it is converted to stock. The convertible arbitrageur has to evaluate the market and the company’s performance very carefully during the time span. Suppose the share price of the company falls during the period, because of poor performance. Therefore, holding such share would be no use and the waiting time of bondholder is a waste of time.

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