Once an inefficiently priced security has been identified, factors should be recognized so that so that it can be capitalized on. If the security is also highly volatile, the potential additional performance may not be worth the risk required. In other words, if you had to lean over a cliff rail to grab a $10 bill, would it be worth it to you?
Arbitrage is the name given to the general strategy used to reduce the volatility of returns in order to capture an opportunity presented. When a convertible bond is inefficiently priced, it is relative to the underlying company's equity and debt. Most often, the volatility of the equity can be removed from the equation by borrowing and selling the stock that the convertible bond can be exchanged for. The volatility of the debt can be removed through an exchange with a third party, otherwise known as a swap. Although, a swap comes with the additional risk of the third party reneging on their half of the trade, and consequently there may be a price to pay. If one or both methods are used to reduce the volatility of return however, it leaves greater relative exposure to the actual inefficiency in the pricing of the convertible security.