WAM and average life for pass-through securities


When interest rates go down I understand that the average life of a pass through security will shorten. However, wouldn’t the WAM (Weighted average maturity) also be reduced since some of the mortgages are prepaid? Would the average life decrease by a larger percentage than the WAM or could both decrease by similar percentages? For instance, if the prepaid mortgages are the one with the highest weights and longest maturities in the pool, wouldn’t this also have a significant impact on the WAM?

Thanks in advance

I think it’s a real-life example that is hard to answer based on what I learn so far. it would be nice to have a question from CFA curriculum so can find a similar answer to it.

Short answer yes it will. WAM is prospective so at every instance of prepayment the future WAM would reduce. However, what you might be missing is the protection to the sr. or the PAC tranches… To the extent they are shielded by the support and subordinated tranches their maturity would remain intact regardless of what happens to the prepayment.

It is only when the sub. or the support tranches exhaust their principal the cover is blown and the PAC or sr. tranches are exposed to prepayment risk and thus curtailment. They are busted now