There isn’t a very clear definition in the book so I did some research online, it seems that WAL and WAM are 2 completely different concepts. WAM is easy, as the name suggested it is the weighted average maturity of a pool of fixed income debts like mortgages. However, I couldn’t seem to understand what WAL is and what’s the meaning of it.
From Investopedia, it says: “WAL shows how many years it will take to receive roughly half of the amount of the outstanding principal.”
However, from the CFA textbook, it says: “WAL gives the investor an indication of how long investors can expect to hold the MBS before it is paid off”
I think these two definitions are contradicted to each other…
Here’s an example from FINANCE TRAIN:
Assume a $10,000 mortgage with a maturity of 30 years and coupon of 6%. The monthly payments will be $59.96
For this loan, the WAL will be calculated as follows:
WAL = (59.96 * 360 – 10,000)/(10,000*0.06) = 19.31
What’s the logic behind this calculation? What do this 19.31 years mean? If there is a prepayment rate (Like SMM or CPR), How could we incorporate the prepayment rate into the WAL calculation?
Thank you so much guys!