The Value of a Vanilla Bond - Coursework Example

Between the two companies it has been observed that Microsoft Corp. has the highest credit rating in the country. Due to the volatility of Aon’s operations and lower credit ratings, interest rates are higher, which makes the investment in Microsoft Corp. safer than that in Aon Corp, from an investor’s point of view. The Value of a Vanilla Bond A vanilla bond is a bond that has no underlying features, a fixed rate is implied and the bond is redeemable in full on maturity. In this paper, the vanilla bonds of two companies will be focused on to determine why the price of one company’s bonds differs from the price of the bond of the other company.

The companies that are being focused for this paper are Microsoft Corp. and Aon Corp. According to the financial results reported by Microsoft Corp and Aon Corp. the companies had a total of $11.9 billion and $2.9 billion outstanding in debt. This debt component comprised of different loan notes, each with a varying range of maturity dates, out of them only the loan notes that fulfill the criteria of vanilla bonds will be considered for this paper. To calculate the present value of these bonds, each lone note will have to be dealt with separately.

The list of the amount of these loans, their coupon rates, price and their maturity dates is mentioned below, and on its basis the present value of each note will be calculated. . October 2020 1,000 3.000% 105.7 941.85 2.27 February 2021 500 4.000% --- 459.79 --- June 2039 750 5.200% 122.0 612.653 3.88 October 2040 1,000 4.500% 113.6 835.607 3.73 February 2041 1,000 5.300% --- 805.150 --- TOTAL 10,750 10,043.51 AON CORP: Maturity Date Face Value ($ Millions) Standard Coupon Rate Price Present value ($ Million) yield to maturity September 2015 600 3.50% 105.0 589.609 2.07 September 2020 600 5.00% 112.1 570.808 3.37 September 2040 300 6.25% 124.8 248.854 4.67 TOTAL 1,500 1,409.

271 As it can be seen, the bonds held by Aon Corp are generating higher yield to maturity than the bonds held by Microsoft Corp. Even though the time till maturity of the two companies is same for some bonds, still Aon Corp is charged with a higher rate of interest than Microsoft Corp. For the bonds that will mature till the years 2015, 2020 and 2040, the respective yields to maturity for Microsoft and Aon Corp. are 0.64, 2.27 & 3.73 and 2.07, 3.37 & 4.67 respectively. Thus it is obvious that the bonds issued to Aon Corp are receiving a better price than that of Microsoft Corp.

According to Standard and Poor’s Rating Services and Moody’s Investor Service Inc. the Microsoft Corporate credit rating is AAA and Aaa respectively, whereas that of Aon Corp is BBB+ with a stable outlook and Baa2 with a negative outlook respectively. The increase in Microsoft’s credit ratings ensures lower borrowing costs and easy access to financial options for the company. Microsoft was assigned top rating right after the company made public a $ 2 billion commercial paper program and according to S&P only five U.

S non-financial companies hold AAA rating according to their standards (Linnane, 2008). The commercial paper of Microsoft Corp is rated A-1+ by Standard & Poor and P-1 by moody’s.