The CDS rate on a defaultable bond is approximated by which of the following expressions:

The CDS rate on a defaultable bond is approximated by which of the following expressions:
A . Hazard rate / (1 – Recovery rate)
B . Loss given default x Default hazard rate
C . Credit spread x Loss given default
D . Hazard rate x Recovery rate

Answer: B

Explanation:

The CDS rate is approximated by the [Loss given default x Default hazard rate]. Thus Choice ‘b’ is the correct answer.

Note that this is also equal to the credit spread on the reference bond over the risk free rate. Therefore credit spreads and CDS rates are generally the same. Also, ‘loss given default’ is nothing but (1 – Recovery rate). This can be substituted in the formula for the credit spread to get an alternative expression that directly refers to the recovery rate. Therefore all other choices are incorrect.