VM reports larger size than VHD file

I have a VM that was created using DiskToVHD - from a hardware server. Its OS is Server 2008 R2 Enterprise.

The size of the VHD on the host is about 40GB.

If you connect to the VM and go to Disk Management, it reports 139GB.

I understand how this happened - the VHD it was copied from was 139GB. But, I do not know how to fix it.

I did defrag it and then used disk management to shrink the volume, but it only shaved about 13GB.

Would a third-party defrag tool do a better job and allow me to shrink it more? If so, any recommendations?

I am flummoxed on this one. Any thoughts out there? Can this disparity in sizes cause problems?

Cathy Burnham, MCSA