Weighted Average Life (WAL)

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Weighted Average Life (WAL)

Weighted Average Life (WAL) measures the average time each dollar of unpaid principal on an amortizing loan, mortgage, or bond remains outstanding. Unlike measures that include interest, WAL considers only principal repayments, so it indicates how quickly principal is returned to investors.

Why WAL matters

  • Focuses on principal timing, which is central to credit risk: the faster principal is returned, the lower the risk of loss.
  • Helps compare amortizing securities: investors favor shorter WALs because they recover capital sooner.
  • Useful for portfolio management and cash‑flow planning (but not a complete risk measure — see limitations).

WAL formula

WAL = (Σ (t × P_t)) / (Σ P_t)

Where:
* t = time period (years, months, etc.)
* P_t = principal repaid in period t
* Σ P_t = total principal repaid (typically the original principal for a fully amortizing instrument)

Example calculation

Assume annual principal payments over five years: $1,000, $2,000, $4,000, $6,000, $10,000. Total principal = $23,000.

  1. Multiply each payment by its year:
  2. Year 1: 1 × $1,000 = $1,000
  3. Year 2: 2 × $2,000 = $4,000
  4. Year 3: 3 × $4,000 = $12,000
  5. Year 4: 4 × $6,000 = $24,000

  6. Year 5: 5 × $10,000 = $50,000

  7. Sum weighted amounts = $91,000.

  8. WAL = $91,000 ÷ $23,000 ≈ 3.96 years.

Interpretation: about half the principal is repaid by roughly year 4 (cumulative principal through year 4 = $13,000, slightly more than half of $23,000). Because the largest payment occurs at the end, WAL is closer to the bond’s full term.

If payments are rearranged (e.g., swapping year 2 and year 5), the timing changes:
* New weighted sum = $67,000 → WAL = $67,000 ÷ $23,000 ≈ 2.91 years.

This demonstrates how shifting larger principal payments earlier shortens WAL and returns capital sooner.

Limitations and caveats

  • WAL ignores interest payments; it only describes principal timing.
  • It assumes scheduled payments occur as expected. Prepayments, defaults, or call features can materially shorten or lengthen actual WAL.
  • For securities with significant prepayment risk (e.g., mortgages or mortgage‑backed securities), WAL is an estimate that may change with borrower behavior or interest‑rate movements.

Bottom line

WAL is a straightforward, principal‑weighted average timing metric that helps investors assess how quickly they can expect to recover principal from an amortizing loan or bond. A shorter WAL generally implies lower credit exposure to principal, but investors should consider prepayment and default risks when relying on WAL for decision‑making.