Chartered Financial Analyst Level 2

Explanation

In convertible bond arbitrage:

• The manager buys a convertible bond (long position)
• Takes a short position in the underlying stock

Delta Analysis:

• Convertible bonds have positive delta (they increase in value when the underlying stock price increases)
• Short stock position has negative delta (it loses value when the stock price increases)

As stock price increases:

• The convertible bond's delta decreases because the bond becomes less equity-like and more bond-like
• The short stock position's delta remains constant at -1 (for each share shorted)

Net effect: The overall position delta decreases because:

1. The convertible bond's positive delta decreases
2. The short stock's negative delta remains constant
3. The net positive delta becomes smaller

This is characteristic of convertible bond arbitrage strategies where managers aim to maintain delta-neutral positions, and as stock prices move, they need to rebalance their positions to maintain neutrality.