What is the arbitration of the capital structure?

The arbitration of the capital structure is an investment strategy that seeks to use the differences between different shares and debt products issued by the same company. Investors using strategy will see such disparity and then buy or sell assets based on a logical assumption that the market will correct the disparity. Unlike some other forms of arbitration, the arbitration proceedings of the capital structure do not try to offer a guaranteed profit. The simplest example is when the asset is traded at different prices in different markets. Theoretically, the investor can use the immediate advantage by purchasing at a lower price and sales at a higher price. In fact, this can be limited both by transaction costs and the possibility of changing prices in the short period between the two transactions. Another example of arbitration is when a player uses different bookmakers who offer different chances, for exdostat, the ability to bet on two possible results, both contradicts that offer better than 1: 1 return.

The arbitration of the capital structure will use this philosophy for two different products issued by the same company. In many cases, one product will be based on its own capital, such as stocks, the other is debt -based, such as bonds. With this type of arbitration, the idea is not to use the disparity almost accompanying basis, but to use the fact that the market should move in the long run to move this disparity in the future. A good example is when news of a company that suggests that it works particularly bad. In such a situation, its bond prices and stock prices are likely to fall hard, but the stock price is likely to fall by a larger level for several reasons: StockholdDers are exposed to a greater risk of loss if the company is liquidated because bond holders are priority; Dividends are likely to be reduced or dropped completely while the annual debt paymentsHestes are determined; And the stock market is usually more liquid, which means it responds to the news more dramatic. The investor who knew he could invest it to take advantage of his expectations that shares would become quite cheaper than bonds, along with the possibility that the balance between them would be later if the company recovered.

If the company issues two types of bonds, standard bond and convertible bond that can be exchanged for the company's shares, the relationship in the price of both bonds should be relatively consistent, with a dispersion depending only on the current price of shares and dividend levels. Someone who uses the arbitration of capital structures to normal levels.