Suppose that:

(a) The yield on a 5-year risk-free bond is 7%.

(b) The yield on a 5-year corporate bond issued by company X is 9.5%.

(c) A 5-year credit default swap providing insurance against company X defaulting costs 150 basis points per year. What arbitrage opportunity is there in this situation? What arbitrage opportunity would there be if the credit default spread were 300 basis points instead of 150 basis points? Give two reasons why arbitrage opportunities such as those you identify are less than perfect. Lop58