The Average Weighted Value Vs. Duration in Mortgage-Backed Securities

The terms average weighted value and duration would apply to a portfolio of mortgage-backed securities, or MBS. These metrics provide detail about the characteristics of an MBS portfolio, including how its overall value will react to changes in interest rates.

Average Weighted Value

Bond investments, including mortgage-backed securities, can be market priced higher or lower than the face value of the bond. Bond prices are listed as a percentage of the bond value. For example, a $100,000 MBS priced at 105 would have a current market price of $105,000. The average weighted value or price includes the prices of all the bonds in a portfolio adjusted for the size of each bond in the portfolio. In other words, the average weighted value is the average market price of the whole portfolio on an equal-dollar basis.

Premium and Discount MBS Values

An average value above 100 indicates the portfolio MBS are at a premium to the principal values. Premium prices are significant with mortgage securities since principal is paid off every month as homeowners whose mortgages back a mortgage security make house payments and pay off or refinance loans. Repaid principal comes into the portfolio at a value lower than indicated in the security values. If the mortgage securities are priced at a discount — below 100 — returning principal payments increase the value of the portfolio.

Portfolio Duration

For a mortgage-backed securities portfolio, duration is a measure of the portfolio value sensitivity to changes in interest rates. The duration calculation is a mathematical formula that calculates the amount of time to earn back the cost of a bond from interest and principal payments. The duration includes the effects of bond prices, coupon rates and principal repayment rates on mortgage securities. For an investor, the duration number is an accurate estimate of how much the value of the MBS portfolio will change with a 1 percent change in market interest rates.

Using Duration

Mortgage-backed security prices move inversely to changing interest rates. Rising rates will result in lower MBS values. If you expect interest rates to rise, you want to invest in mortgage securities or an MBS fund with a short duration, resulting in stable prices. If you think interest rates will decline, a longer duration will result in a greater market price increase and a longer retention in the portfolio of the current higher-yielding mortgage securities.