Investments, tenth edition

 Example  26.1 

Market-Neutral Positions 

 Long-short positions such as in Example 26.1 are characteristic of hedged strategies. They 

are designed to  isolate  a bet on some mispricing without taking on market exposure. Profits 

are made regardless of broad market movements once prices “converge” or return to their 

“proper” levels. Hence, use of short positions and derivatives is part and parcel of the industry. 

 A more complex long-short strategy is  convertible bond arbitrage,  one of the more 

prominent sectors of the hedge-fund universe. Noting that a convertible bond may be 

viewed as a straight bond plus a call option on the underlying stock, the market-neutral 

strategy in this case involves a position in the bond offset by an opposite position in the 

stock. For example, if the convertible is viewed as underpriced, the fund will buy it and 

offset its resultant exposure to declines in the stock price by shorting the stock. 

 Although these market-neutral positions are hedged, they are  not  risk-free arbitrage 

strategies. Rather they should be viewed as