Company X invests in numerous fixed income instruments and has a large long position on bonds issued by ABC Bank in the amount of $150MM. Given the unstable rollout of the vaccine and economic headwinds posed by the pandemic, the threat of a prolonged recession in Europe has started to creep into the system. ABC Bank has significant exposure to Europes major economies and is putting significant strain on the banks liquidity position. The chief investment officer of Company X is concerned about the risks that the deteriorating credit perception of banks can pose on his bond portfolio and on his ABC Bank holdings specifically. He is looking at buying protection by entering into a five year credit default swap on his ABC Bank bonds. The current default probabilities are at 25% while the recovery rate is at 45%. Defaults happen midway through the year.

1. Assuming a risk-free rate of 1.50%, what would be the premium that Company X would pay if it wanted to enter into a long position on a credit default swap on its ABC Bank holdings? If you were the chief investment officer would you enter into these credit default swaps? Why or why not?
2. If your belief is that you were at the worst stage of the crisis and you had a view that an ultimate resolution to the situation was coming within the next two years, how can you profit from this situation using credit default swaps?