The weighted average maturity, or WAM, is calculated to compare portfolios comprised of mortgage-backed securities. The calculation figures the average time a loan takes to fully mature weighted by the amount of principal left to be paid on the loan. The higher the WAM figure, the longer the durations left on the maturity terms of the mortgages in the portfolios. On the other hand, a portfolio with a lower WAM, typically contains more mortgages that are close to the loan’s maturity date.
Why WAM Matters
When you invest in mortgage-backed securities, you are in essence purchasing a portion of the debt associated and packaged with the security. Investors will often use WAM to determine how sensitive to interest rate risk their portfolios that contain mortgage-backed securities may be. The weighted calculations give a better representation of how long it will take before each dollar on average is received by the lender than a simple, unweighted arithmetic average. However, the weighted average loan maturity is also of importance to borrowers and investors as well.
If a portfolio has a lower WAM, investors are exposed to less interest rate risk because of the shorter duration before the mortgages in the portfolio mature. On the other hand, a large WAM figure can mean a higher degree of risk for an investor. Because the portfolio is comprised of mortgage-backed securities that have a longer time to maturity, there is a higher chance that changes in interest rates can have an impact on the portfolio.
How To Calculate WAM
Simply put, you calculate the WAM by adding up the value of each loan and then dividing this amount by the total value of all the loans in the portfolio. This will determine the weight percentage. To complete the equation, you need to multiply the total you arrived at for the weight by the number of years left until the loan matures.
An Example of Calculating WAM
Although it sounds somewhat complicated, it’s actually a pretty straightforward calculation. For example, assume you want to find the WAM of three loans, one for $2,000, another for $5,000 and lastly one for $10,000. First, you must total all the loans together, in the above example this equals $17,000. Next, you need to determine the weight of each loan by dividing the sum of all the loans, in this case, $17,000 by the amount of each loan.
For the $2,000 loan, the weight is 0.12 ($2,000/$17,000); the $5,000 loan has a weight of 0.29 ($5,000/$17,000) and the final loan of $10,000 has a weight of 0.59 ($10,000/$17,000). To double check your work, the combined weights should equal 1; if so, you’re doing well, if not, redo your math. Using the example above, 0.12+0.29+0.59= 1.
Now, you have to take the weight of each loan and multiply this figure by the number of years left until the loan’s maturity. If the $2,000 loan is due in 10 years, then its weight (0.12) multiplied by the number of years left until full repayment (10) is 1.2. A $5,000 loan that reaches loan maturity in 8 years will give you 2.32 (0.29 x 8) and the $10,000 loan with one year left until maturity will give you 0.59 (0.59 x 1). Add all of these figures to determine the WAM, which in the above example would be 4.1, or 1.2 + 2.32 + 0.59. This means that the loans mature in 4.1 years, if you take into account their dollar values.
- Failing to consider the weights and merely adding up 10, eight and one and dividing the result by three -- by using the arithmetic average -- results in 6.3, which differs significantly from the weighted average figure.
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