Before they got the idea of building a wall out of stones and bricks, China's Ming dynasty tried to keep barbarians out using really tall plant formations. This "Chinese Hedge" was a colossal failure (attempts to brand it the "Great Hedge of China" were roundly mocked).
Eh, okay...this is actually the name of a trading hedge. The more culturally sensitive name for this position is a "reverse hedge." It's a way to arbitrage market fluctuations in the prices of convertible securities.
Take a convertible bond. This type of security acts like a standard corporate bond (with an interest rate and maturity date, etc.) and has the added benefit of an option to convert it into shares of stock under certain conditions. Because of this additional benefit, these bonds trade at a premium compared to vanilla bonds from the same company with similar rates and maturities.
In a Chinese hedge, you are attempting to profit on a potential overvaluation of this convertibility. Basically, you think the market has priced in too much of a premium for the convertible part of the bond. So you short the convertible security (bet that its price will go down), while going long the underlying stock (basically, buying shares). Then, if the stock goes up, messing up your short on the convertible instrument, the investor can profit on the rise in the stock price.
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Finance: What is a Derivative?23 Views
finance a la shmoop what is a derivative? well it's derived it's a something taken
from something else like a derivative of hot weather is thirst a derivative of [Girl takes sip of glass of water on a beach]
hunger is well you know crankiness that's diva thing you get there...
derivative of a 1/32 quarterback rating in the NFL is like serious wealth yeah
yeah discount double shmoop yeah look for it be on there with aaron
and a derivative of a stock or bond or other security is a something which
derives its value based on the performance of that underlying security
there are basically two flavors of derivative put options ie the right to [Ice cream flavors appear]
sell a security at a given price over a given time period and a call option, ie
right to buy a security at a given price over a given time period
well the price of that option is derived from the price of the security and a few
other factors like strike prices and duration and all that stuff
colonel electric the downgraded new version of General Electric is trading [Colonel Electric appears in a suit]
for 25 bucks a share a derivative of its share price is sold in the form of a
call option with a $30 strike price expiring about 90 days from now on the
third Friday of the end of that month well investors pay a price albeit
probably a small one for the right to then pay 30 bucks a share for colonel [Call option appears for colonel electric]
electric at any time in the next 90 ish days until that option expires making the bet
that the stock will go well above 30 bucks a share in that time period that
call option is thus a derivative of the colonel electric primary stock price got
it if you really want to get personal well here's the ultimate form of
derivative [Baby laying down]
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