The bond underlying the CDO in the previous question is rated B and the historical default rate of similar bonds is 6%. Given this information, the CDS spread of 450 basis points may reflect temporary market optimism or pessimism regarding default risk with a recovery rate of 40%.

Assuming the market will return to the historic level of risk appetites during your holding period, what trade(s) could you do to earn a profit or protect against a loss, depending on whether the current spread is too high or too low?

Check all that apply. Only select answers consistent with your determination of whether the current spread is too high or too low.

Group of answer choices

Buy protection CDS

Sell protection CDS

Sell the underlying bond

Buy the underlying bond