Explanation

Convertible bond arbitrage is a hedge fund strategy that involves:

1. Buying convertible bonds - These are bonds that can be converted into a predetermined number of shares of the issuing company's stock.

2. Short selling the underlying stock - The fund simultaneously sells short the stock of the same company.

Why this strategy works:

• Convertible bonds have both bond-like characteristics (fixed income payments) and equity-like characteristics (conversion option).
• The strategy aims to profit from pricing inefficiencies between the convertible bond and the underlying stock.
• When the convertible bond is undervalued relative to the stock, the fund buys the bond and shorts the stock to hedge the equity exposure.
• The fund profits from the convergence of prices or from the bond's yield while being hedged against overall market movements.

Why the other options are incorrect:

• Option A: Buying convertible bonds of companies at or near bankruptcy is more characteristic of distressed debt investing, not convertible bond arbitrage.
• Option C: Buying sufficient convertible bonds to influence company policies describes an activist investing strategy, not convertible bond arbitrage.

Key characteristics of convertible bond arbitrage:

• Market-neutral strategy
• Focuses on relative value between convertible bonds and their underlying stocks
• Typically involves delta hedging (adjusting the short stock position based on the bond's conversion ratio and delta)
• Aims to capture mispricings in the convertible bond market