The preferred stock of Greatest Technology Corporation has a $100 par and is convertible into four shares of common stock. The preferred is trading at 104.50. The preferred is callable at 101. If the common stock price is presently 27.89, which of the following actions would be a successful arbitrage:
- purchase 400 shares of common stock and sell 100 shares of preferred stock as “short exempt” (that is, the sale is exempt from the uptick rule)
- purchase the preferred stock and sell an appropriate amount of the common stock “short exempt”
- purchase both the common and the preferred stocks as a hedge against further market risk
- purchase the preferred stock and let it be called, which is inevitable at these market prices
Answer(s): B
Explanation:
purchase the preferred stock and sell an appropriate amount of the common stock “short exempt”. Arbitrage is the nearly simultaneous purchase and sale of equal securities in different markets for a profit. Selling four shares of common stock for every one share of preferred stock purchased provides a profit. The transactions involve the same number of common shares because the preferred is convertible to common at a four to one ratio.