Relative to a convertible bond, which situation creates a desirable arbitrage opportunity?

In the context of convertible bonds, an arbitrage opportunity arises when a trader can exploit price discrepancies between the convertible bond and the underlying stock. The scenario where the stock is at a premium to parity and the bond is trading at par is particularly advantageous for several reasons.

When the stock is trading at a premium to parity, it means that the market value of the company’s shares is higher than the value of the convertible bond if it were converted into shares. In this case, the bondholder would potentially benefit more from converting the bond into stock rather than holding the bond itself. Since the bond is trading at par, the bondholder still retains the full value of the bond without any loss.

An arbitrageur could buy the bond (if it is undervalued) while simultaneously selling the stock short at the premium price. If the prices eventually converge—either the stock drops, or the bond increases in value—the arbitrageur can realize a profit from the difference. This situation encapsulates the concept of arbitrage by allowing traders to capitalize on pricing inefficiencies between the bond and the underlying stock.

In other scenarios, such as when the stock is trading at a discount to parity or both the stock and bond are trading at a discount, or the