Sabrejet, RE: The retail guy gets smoked in a situation like this while the big boys laugh all the way to the bank!
Actually, I think that a bunch of the "big boys" will implode from convert arbitrage.
First of all, a lot of em over lever their positions at the aforementioned 10 to 1 ratio.
Now imagine this scenario: the economy recovers to the extent that a touch of inflation starts to rear its ugly head. The rising tide helps all boats, Lucent included, and the price of LU common doesn't keep up.
But wait, the convert all of a sudden doesn't keep pace. Why? Because with nominal interest rates rising, a 7.75% coupon isn't as attractive any more. In addition, if greater confidence in Lucent cuts down on the stock price volatility, increased interest rates might not be enough to offset the lower volatility and the imbedded call in the convert might actually decline in value. A 10% discrepancy arises in the price of the convert vs the price of the common. Because the fund is levered 10:1, the fund goes to zero and gets shut down. They aren't able to ride out the price discrepancy. Said arb finds a job flipping burgers. |
