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Explain with an example why the equilibrium CDS spread is equal to a bond s credit spread. In your example, assume a 5 - year

Explain with an example why the equilibrium CDS spread is equal to a bond

s credit spread. In your example, assume a

5 -

year BB bond is trading at

8 %,

the only risk on the bond is credit risk, a

5 -

year Treasury is trading at

6 %,

and the spread on the CDS is

1 % .

Explain the equilibrium relation between credit spread, CDS spread, and probability of default.

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