I'm currently re-reading Benjamin Graham's book, The Intelligent Investor. In it (Chapter 15), Graham mentions some of the undertakings and operations his fund, Graham-Newman Corporation, was involved in. One of them is, as Graham calls them, "Related Hedges". Here is his explanation:
Related Hedges: The purchase of convertible bonds or convertible preferred shares, and the simultaneous sale of the common stock into which they were exchangeable. The position was established at close to a parity basis -i.e., at a small maximum loss if the senior issue had actually to be converted and the operation closed out in that way. But a profit would be made if the common stock fell considerably more than the senior issue, and the position closed out in the market.
From my understanding, Graham is making a profit from the common stock falling far below the senior issues. Here are my questions for "Related Hedges":
How do you make a profit with a "Related Hedge"? Wouldn't senior issues decline in value if the common share price fell?
How do senior convertible preferred shares move in relation to common shares?