Safe Corp. has zero coupon bond with 10 years to maturity and a yield of 5%. Risky Company also has a zero coupon bond with 10 years to maturity, but the yield on the bond is 5.25%. The higher yield on the Risky bond reflects Risky's higher probability of default. Historically, the difference between the yields of the two bonds has been 1%. This difference is called the "yield spread." Today the yield spread is only 0.25%. You expect that the yield spread will widen back to its historic value over the next few days. Assume that both yields will change equally to bring the spread back to its historic position and assume that the mid-point of the spread will stay where it is. What positions do you take in the two bonds to profit from the expected changes?
◦ Long the Risky bond; Long the Safe bond
◦ Short the Risky bond; Short the Safe bond
◦ Short the Risky bond; Long the Safe bond
◦ Long the Risky bond; Short the Safe bond
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