Assume 1-year LIBOR is 1.00%, and a risky bond has a rate of LIBOR + 5% [This means that the risk-free bond has a rate of LIBOR (or 1%)] Assume interest is paid/received quarterly. Each bond is priced at par of $100 and has 1 year to maturity. Assume that an investor buys the risky bond and short sells the risk free bond. Assuming the underlying bond defaults in the fourth quarter with a payout of $40. this trade:

I. replicates selling credit protection using a CDS

II. replicates buying credit protection using a CDS

III. Results in a net positive cash flow of $58.75 in the last quarter

IV. Results in a net negative cash flow of $58.75 in the last quarter