I think you're a bit confused, Sabre.
An arb buys $1mm of the convert and shorts $1mm of the common (well, not exactly that, but I won't get into the dynamic part of the hedge). The arb then gets 7.75% interest on the convert and a little less than the fed funds rate for interest on the short sale. That means that the arb will get around $90,000 annually in interest from this position. Now let's say that the arb levers the position 10 to 1, meaning that he uses $100,000 in equity to support the position. On the borrowed money an arb might pay fed funds plus a hundred basis points, or about $25,000. That cuts the income back from $90,000 to $65,000.
$65,000 in income on $100,000 equity. That's a pretty handsome return. And that return is earned every year the convert is outstanding. If the arb had the choice he'd keep the position open until the maturity of the preferred in 2017. Contrary to what you think, the arb would want to be short this stock as long as possible. |
