A bank is issuing a risky 10-year floating rate bond where the face value is $1,000. The bond is sold at par, and the coupon in each year t, from t = 1 to t = 10, is equal to (LIBORt1,1 0.3%) 1000. Assume that at t = 0, the 10-year swap rate (where the floating leg is 1-year LIBOR) is 8%, and the yield curve is flat at 7%. Suppose the CDS premium on the risky bond is 90bps per year. A default can only happen right after a coupon payment and the exchange of CDS premium. There is no counterparty risk.

In the event of a default, the yield curve will not necessarily stay flat at 7%, and the swap rate will not necessarily remain at 8%. However, you can assume that the swap spread will remain the same.

Describe how you would construct an arbitrage. Make sure to describe exactly what you would do if a default happens.