Many bonds pay their principals as a single sum when the bond matures. Other bonds amortize their principals by paying their principals in installments over the course of the bond's life. With these bonds, investors like to receive their returns as soon as possible. The bond's weighted average life helps investors gauge how quickly bonds pay out returns. The average life is the average length of time that each dollar in the principal remains unpaid.
Multiply each of the bond's payments by the number of years until the issuer pays each of them. For example, if a bond pays $1,000 after one year, $2,000 after two years and $4,000 after three years, multiply $1,000 by 1 to get $1,000, multiply $2,000 by 2 to get $4,000 and multiply $4,000 by 3 to get $12,000.Step 2
Add together these time-weighted sums. Continuing the example, add $1,000, $4,000 and $12,000 to get $17,000.Step 3
Add together the bond's payments. Continuing the example, add $1,000, $2,000 and $4,000 to get $7,000. This is the bond's total principal.Step 4
Divide the sum of the time-weighted payments by the bond's principal. Continuing the example, divide $17,000 by $7,000 to get 2.4. The bond has a weighted average life of 2.4 years.
- You can also calculate the weighted average life of an entire bond portfolio, in which each payment results from a different bond's maturity.
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