Convertible Bonds of Countrywide Financial Corporation

Late in the afternoon on Friday, October 22, 2004, the trading floor at First Convergence Inc. was relatively quiet, as most traders had left for the weekend. However, Mary Lucas, a junior trader, was still sitting in front of her Bloomberg terminal, browsing through the recent trading activities of a few convertible bonds the firm held. First Convergence Inc. was a hedge fund specializing in convertible arbitrage that had been founded by three Wall Street traders in 2002. Lucas had joined the firm only recently after getting her MBA. Prior to starting at the firm, she had known little about convertible bonds. Now she stayed late almost every day in order to learn as much about the business as possible. Suddenly, she noticed something unusual about the trading of a convertible bond issued by Countrywide Financial Corporation (NYSE:CFC). Although the average daily trading volume on this bond had been only three thousand during the previous month, it had shot up to fifty thousand in the last three days. Lucas remembered this particular bond. In fact, First Convergence was actually holding a slightly different convertible bond (known as the liquid yield option note or LYON) issued by the same company. On August 20, Countrywide had offered to exchange the new convertible bond for the original LYON. First Convergence had accepted the exchange offer, thus ending up with the new convertible bond. At that time, Lucas was asked to help evaluate the offer, so she was familiar with the features of both bonds. "What's happening?" she asked herself. She quickly checked the recent price movement on Countrywide's stock. The stock had plunged 11.5 percent on Wednesday, October 20, after the company announced an earning below analysts' expectations. On the same day, trading on the convertible shot up. These two events must be related. But how? Is there a potential investment opportunity?