Answer to Question #272171 in Finance for BSN

Question #272171

Suppose that

i. The yield on a five-year risk-free bond is 3.0%

ii. The yield on a five-year corporate bond issued by company X is 6.2%

iii. A five-year credit default swap providing insurance against company X defaulting costs 280 basis points per year.

(a) What arbitrage opportunity is there in this situation?

(b) What arbitrage opportunity would there be if the credit default spread were 340 basis points instead of 280 basis points?

(c) Give two reasons why arbitrage opportunities such as those you have identified may be less than perfect in a real-world situation.

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