Why AA bonds?
The purpose of valuing liabilities in a transaction is to make sure that the deal price as a whole reflects the costs and risks of the pension liabilities being taken on. Pensions are seen as a series of unsecured payment promises into the future and, as such, share many attributes with corporate debt. For this reason, they are valued in a similar way as corporate debt. However, in valuing corporate debt, a key aspect is the credit risk involved; the value of a known stream of payments from a risky company (such as one that is below investment grade) is lower than for a strong company (for example, one rated AAA) and debt trades at a lower price (with a higher yield) to reflect this. In principle, for similar reasons, a weak company’s unfunded pension promise is worth less than the same unfunded promise from a strong company. In addition, secured debt is expected to trade at a higher price (and lower yield) than unsecured debt. This is because, in the event of default, the investor can
