Introduction
The Aetna Company is situated in the United States. It offers diversified health services such as medical, pharmacy and medical services. It also offers behavioural health plans and disability plans. Its services are offered under the three sections of health care, group life and large scale pensions. The healthcare section provides Medicare and Medicaid services in addition to the medical, pharmacy and dental services. The group life section offers accidental, dismemberment, life, disability and spouse life insurance services. The third section, large scale pension offers services such as pension and annuity plans for the employees, the individuals who are self-employed and even the students (Aetna, 2011).
The ACE limited company provides insurance and re-insurance services in various locations through its subsidiaries. The North American subsidiary provides several insurance products in property, worker’s compensation, marine, automobile, accident, and salvage and disaster recovery programs. There is an overseas general insurance segment that covers areas such as political risk, professional risk, marine, aviation and energy insurance. There is a life segment that offers whole life, endowment products, accident and personal life products. Lastly, the Global Reinsurance segment offers products in property catastrophe and medical malpractice reinsurance (ACE 2011).
In this paper, I shall compare the bond prices of the company’s long term debt that are due in 2015 and 2016 for ACE limited and Aetna Limited respectively.
Investors and creditors compare the bond values and prices of companies to ascertain certain information. In calculating the bond value, there is certain information required. First of all, one needs to calculate the yield to maturity. Four items are required, that is bond par value, market price, the coupon rate and the maturity date. The bond par value refers to the maturity value. If the investors wait till the maturity date, this is the amount of money they will receive. The bond par value is also known as the principle amount or the face value. The bond market price is the prevailing current value of the bond in the market. The prices fluctuate and are dependent on three factors that is the interest rates and buyer’s desire or interest. The institution’s financial condition will also affect the market price of the bond. If the bond’s par value is higher than the market price then the bond is deemed to be selling at a discount. The ACE and Aetna bonds are both selling at a discount. The par value for ACE’s bond is $500 yet the prevailing market price is $447.The Aetna’s bond market price is $747 while the par value is $750.
When a bond’s market price is higher than the par value, the bond is selling at a premium. The maturity date of the bond is the time the company is expected to retire the bond. There are certain bonds that allow the company to retire their bonds before their maturity date. Once the company pays up the bond, it is no longer obligated to pay any more money. It will have paid the principal and the interest payments. The coupon rate is the rate on the bond certificate. It is the rate of interest that the creditors are entitled to on the bond yearly. Assuming a bond that has a coupon rate of 9% and the par value is $1000, the creditor is entitled to an interest of $90 each year till the maturity date of the bond.
The current bond yield is based on the bond’s market price and the coupon rate. Taking the bond with a par value of $1000, coupon rate of 9% and a market price of $900, the current bond yield would be 9% of $900 which is $81. The yield to maturity is the measure that enables the investors to analyse all the possible returns of the bond. The yield to maturity is always shifting due to the fluctuating market conditions and prices.
In looking at the bond value of the two bonds, the bond for ACE limited has been overpriced. The value of the bond is $440 yet the market value is $447. The bond for Aetna however is correctly priced, the value is $747 and the market value is $747. The bond for the ACE Company is receiving a better price than the Aetna bond. The bond is performing better and the market perception of the company is very optimistic. Due to the bond pricing, the ACE Company will receive a better credit rating from the rating agencies as the bond has a great price in the market. Credit ratings are very important to companies since most of the time to conduct capital expansion they usually have to borrow money from banks and other financial institutions. The banks will therefore feel more secure lending money to the Aetna Company rather than the Aetna Company. The fact that the ACE bond fetches a better price in the market also shows that the company has the capability of raising higher amount of funds from the market.
The bond for Aetna’s company has a coupon rate of 6% which is higher than the rate of AEC rate at 2.6%. The fact that the ACE bond gives the debtors a lesser rate yet is overpriced shows the financial health of the company and the positive perception of the company in the market. Banks charge higher interest rates to companies where they believe the risk of default is higher. If a company’s finances are not healthy or it is highly leveraged, the bank will prefer to charge high interest to protect its interests. It is also a way for the company to limit the company from engaging in many lending contracts or situations. Higher interest rates ensure that the bank recoups much of its principle quickly in the early years.
Credit ratings are very important to the investors. A great credit rating encourages the investor to invest more of his money into the company however the poor credit rating discourages investors or makes them invest lesser money into the company in order to mitigate their risks. The investor has to diversify his risk. From a company’s point of view the ACE bond looks very attractive due to its overpriced values.
There are several factors that influence the dividend payment policy of a company. If the company’s earnings growth is increasing at a stable rate, the company may have a better payout ratio. New companies prefer to pay less dividends in order to plough back much of the profit back into the company for investment in long-term projects. Established companies will be much more comfortable paying higher dividends. A dividend payout is usually in the form of cash. Payments of dividends therefore signify a reduction in the liquidity of the company. If a company has a great current ratio, it will be better placed to pay cash dividends however it would if the liquidity is low, it will prefer to pay stock dividends. In private companies, the directors are able to convince the shareholders the justification of lower dividend payout ratio or the total suspension of payment of dividends.
In public companies, the payment of dividends and an increasing dividend payout growth is perceived positively by the market. The public company may have to seriously plan its dividend payout strategies. Where the company has several capital expansion projects, more income will be ploughed back into the company. During financial booms, the company will still choose to retain higher earnings in the business. In the recession or the depression periods, the company may still choose to continue with the dividend payout ratio in order to signal to the market, the attractiveness of the company’s securities and prove financial solvency. High taxes also affect the dividend policies. Higher taxes reduce the earnings of the company causing the company to reduce the dividend it pays out.
The past dividend payout ratio will also influence the current payout ratio. If the company suddenly increases the dividends it pays, the market will get into a lot of speculation affecting the stock prices. The directors usually try to maintain the average rate. Companies with high capability to get credit facilities from the bank and the market usually pay out higher dividends. The smaller firms will prefer to build up their retained earnings reserve to use for their capital projects. There are also legal influences on the distribution of dividends that reduces the rate of dividends payout. Companies are not allowed to pay dividends out of capital reserves. In emergency situations, the government may also restrict the payment of dividends. Companies that have high loan obligations also prefer to retain much of their earnings.
Companies with lesser obligations pay out lesser dividends. The companies will also structure themselves to pay out dividends in times where the company has lean expenditure. The companies are also under market pressure to pay constant dividends in order not to create panic in the market. Companies where the directors want to maintain a higher control in the company may prefer to pay low dividends in order to prevent new shareholders from purchasing shares.
Both shares are overpriced however the ACE shares are more highly overpriced. The company has been earning higher profits and the market perception and expectation is high that the company will perform even better. An investor should therefore purchase the shares of both companies. However, the ACE Company shows a more healthy financial life than the Aetna stocks. An investor should consider more factors than whether the share is overpriced or underpriced. The individual investor should scrutinise the financial statements to find out the long-term growth of the earnings using such as criteria as the net income, sales revenue and diluted EPS over the years.
If a good stock keeps having a steady growth over the years the price of the stock will keep increasing as the market is optimistic about its future performance. An investor will still be able to buy the share when it has a high price and sell the shares for capital gains when the prices have even gone higher. The investor’s first choice should be the Aetna’s stock because the financial performance of the company is better. The share price of the company is even higher. I believe that in the future the shares of the AEC Company will outperform the performance of the Aetna shares.
References:
ACE (2011). 2010 Annual Reports. Retrieved from:
www.acegroup.com/.../ACE-Limited-Annual-Report-2010.pdf
Aetna(2011). 2010 Annual Reports. Retrieved from: www.aetna.com/2010annualreport/
Yahoo Finance (2011). ACE Limited Common Stock. Retrieved from:
http://uk.finance.yahoo.com/q?s=ACE
Yahoo Finance (2011). Aetna Limited Common Stock. Retrieved from:
http://uk.finance.yahoo.com/q?s=AET
Peterson, P. (2011). Dividend Valuation Models. Retrieved from:
http://educ.jmu.edu/~drakepp/FIN362/resources/dvm.pdf
