So what exactly is Weighted average life of a MBS? How is it different from WAM?

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!

I don’t know the answer and I don’t see the formula to calculate the weighted average life in CFA curriculum. I just add what I think about WAM and WAL. :grinning:

Like you point out, the weighted average of maturity(WAM) and the weighted average of life(WAL) are two different things.

WAM is the weighted average life by each remaining maturity relative to the whole maturity of a pool of mortgages
WAL is the average life of the mortgage-backed security an investor would hold under different PSA.

In 5.1 Exhibit 2, the WAM is 357 months and the WAL is 8.6 years under 5.1.5, showing this mortgage-backed security I would need to hold 8.6 years to gain 5.5 % as the pass-through rate.

then your example tells me if I invest in your mortgage-backed security, I would need to hold 19.31 years to gain x% from the pass-through rate. :wink: