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+Chapter 27: Arbitrage 437 
+a riskless strategy, such a loss may have the effect of putting them out of business. 
+That is an unnecessary risk to take. There are countermeasures, as described above, 
+that can reduce the effects of the four risks. 
+Let us consider the risks for conversion traders more briefly. The risk of stock 
+closing near the strike is just as bad for the conversion as it is for the reversal. The 
+same techniques for handling those risks apply equally well to conversions as to 
+reversals. The other risks are similar to reversal risks, but there are slight nuances. 
+The conversion arbitrage suffers if there is a dividend cut. There is little the 
+arbitrageur can do to predict this except to be aware of the fundamentals of the com­
+pany before entering into the conversion. Alternatively, he might avoid conversions 
+in which the dividend makes up a major part of the profit of the arbitrage. 
+Another risk occurs if there is an early assignment on the calls before the ex-div­
+idend date and the dividend is not received. Moreover, an early assignment leaves the 
+arbitrageur with long puts, albeit fractional ones since they are surely deeply out-of­
+the-money. Again, the policy of establishing conversions in which the dividend is not 
+a major factor would help to ease the consequences of early assignment. 
+The final risk is that interest rates increase during the time the conversion is in 
+place. This makes the carrying costs larger than anticipated and might cause a loss. 
+The best way to hedge this initially is to allow a margin for error. Thus, if the pre­
+vailing interest rate is 12%, one might only establish reversals that would break even 
+if rates rose to 14%. If rates do not rise that far on average, a profit will result. The 
+arbitrageur can attempt to hedge this risk by shorting interest-bearing paper that 
+matures at approximately the same time as the conversions. For example, if one has 
+$5 million worth of 3-month conversions established at an effective rate of 14% and 
+he shorts 3-month paper at 12½%, he locks in a profit of 1 ½%. This is not common 
+practice for conversion arbitrageurs, but it does hedge the effect of rising interest 
+rates. 
+SUMMARY OF CONVERSION ARBITRAGE 
+The practice of conversion and reversal arbitrage in the listed option markets helps 
+to keep put and call prices in line. If arbitrageurs are active in a particular option, the 
+prices of the put and call will relate to the stock price in line with the formulae given 
+earlier. Note that this is also a valid reason why puts tend to sell at a lower price than 
+calls do. The cost of money is the determining factor in the difference between put 
+and call prices. In essence, the "cost" (although it may sometimes be a credit) is sub­
+tracted from the theoretical put price. Refer again to the formula given above for the 
+profit potential of a conversion. Assume that things are in perfect alignment. Then 
+the formula would read: