One would get 2.7788 shares which they could sell for $400.
I guess i should have been more clear on that. To my (limited) understanding of convertible bonds, the way it would work is at the maturity day (march 1st in this case) you either get your bonds converted to shares (2.7788 shares per bond) or you get the principal back ($1000 per bond) along with the semi annual interest payment (~$1.25). Getting 2.7788 shares per $1000 note amounts to a conversion rate of about $359.87. So you would choose to convert if the SP was above that, and you'd take the money if it was below. (Anyone know if that's automatic, or if you have to tell your broker that you want to convert?)
You've basically got it correct, except that with *these* convertible bonds, Tesla is allowed to pay you cash equivalent to the number of shares you'd get (based on an average stock price for some number of days immediately before maturity) rather than giving you the actual stock.
Also, conversion isn't automatic; you have to tell your broker. *Also*, there's a deadline for deciding whether to convert, and it's well before the maturity date.
I believe you still get the interest payment if you convert, but at a 0.25% interest rate, its pretty inconseqential.
I believe you don't get that last interest payment if you convert. I read through this carefully though I may be misremembering.
So when I said that for your investment of $1006.75, you either get $1001.25 or 2.7788 shares, I meant that if Tesla goes down, you still walk away with your $1001. Your maximum loss is $5.5, or ~0.5%. Meanwhile, if Tesla goes up, you just convert to shares at an effective rate of ~$362 (1006/2.7788). So if it goes to 400, you get $1111.5 (400*2.7788) or a gain of 10.5%.
The point isn't really to make mad gains. If Tesla's going up you get roughly the same return. A little less, in fact. But if it goes down, you take almost no loss, because instead of converting to shares, you take the money.
This is correct.
The thing I don't understand is that taking away all the risk should be worth more than just 0.5%. So I can't figure out why the bonds are priced so low.
This is a... drumroll...
arbitrage opportunity.
Let me explain the arbitrage. Purchase, say, a million dollars worth of the bonds, for $1,006,700. This can be converted to 2778.8 shares. Sell 27 call option contracts expiring Feburary 19 (or, actually, before whatever the conversion deadline date is for the bonds), for a strike price of $370. This obligates you to sell 2700 shares of TSLA for $370 if the guy on the other side wants you to. These are trading at $31.50, so you receive $85,050 up front.
If Tesla is trading below $359.87 at expiration, you cash out the bond for $1,001,250, and the calls expire -- your gain is 1,001,250 - 1,006,700 + $85050 = $79,650.
If Tesla is trading between $359.87 and $370 at expiration, the bond converts, but the calls expire -- you get 2778.9 shares of TSLA for an effective price of $362.28. Your worst-case loss here is to sell these immediately at $359.87, realizing $1000042.74. So your net gain is 1,000,042 - 1,006,700 + 85050 = $78,392.
If Tesla is trading above $370 at expiration, the bond converts and the call executes. You get 2778.8 shares of Tesla; you deliver 2700 of them to satisfy the call, and sell the remaining 78.8 (at a worst-case price of $370). So you receive $1,028,156 from the sales, and your net gain is 1,028,156 - 1,006,700 + 85050 = $106506.
I believe this might be able to be done with a call with a strike of $350 or $360 for a larger arbitrage proftit, but I worked out the math for $370; there's extra cases in the $360 case and more in the $350 case, and there may be one with some serious risk, I didn't go through them all.
There's also the risk of timing mismatches; not being able to match up the trade timing and facing a large move against you between the stock conversion and the sale of the stock (when it's not called away) but these can probably be kept below the arbitrage profit minimum.
