What is the purpose of the interest paid on borrowings in convertible bond arbitrage?

In convertible bond arbitrage, the interest paid on borrowings serves a significant role in calculating total returns. When an investor engages in this strategy, they typically purchase convertible bonds, which can be converted into a company's equity at a predetermined price. To amplify the strategy's effectiveness, an investor might short-sell the underlying stock, borrowing shares to do so.

The interest on the borrowed funds for short-selling directly impacts the overall profitability of the arbitrage position. When assessing total returns, it is necessary to account for both the interest expense on the borrowings and the income generated from holding the convertible bond, including any coupon payments. By doing this, investors can accurately gauge their net returns and make informed decisions based on their investment performance.

While other choices touch on aspects relevant to investing or hedging, they don't specifically address the role of interest payments in determining total returns. Therefore, the correct answer highlights the necessity of understanding the complete financial picture when engaging in convertible bond arbitrage.