What is Weighted Average Maturity?
Weighted average maturity is a term most commonly applied to mortgage-backed securities, which are a type of derivative investment made up of many individual mortgages. A calculation based on the combined value of all the mortgages in the security and the time to maturity, or time until final payoff, for each mortgage yields the weighted average maturity. The higher the figure resulting from the weighted average maturity calculation, the longer the assets that underly the derivative security have until final payoff.
The calculation of a weighted average maturity of an investment begins with the total value of all the assets that comprise the security. The value of each asset is then divided by the total value of all assets; that result is multiplied by the years remaining to maturity of the individual asset. That step is then repeated for every individual asset in the portfolio. Adding together the results for each asset provides the average weighted maturity of the security.
In mathematical calculations, the term "weight" refers to the relative importance of one number to others. Dividing the value of one individual asset in a portfolio by the total value of all assets in a portfolio yields the weight of the individual asset relative to the total portfolio. A weighed average goes one step further by calculating the total relative importance of all assets in a portfolio.
For those evaluating a security, the weighted average maturity does not offer any insight into the quality either of the individual investments that underly the security or the cumulative quality of the assets. The figure does give a one-time account of how long the asset will continue to generate income if the underlying assets remain healthy. Reviewing the weighed average maturity over time can give an even clearer picture of the security’s long-term time to payoff, again, assuming the health of the assets that underly it.
The term weighted average maturity is also applied to a calculation used to evaluate bonds. Called the Macaulay duration and named for economist Frederick Macaulay, this calculation is designed to help account for the risk of changing interest rates on the value of a bond. Macaulay determined that unweighted averages were not helpful in attempting to predict such risks. His bond duration discounts the bond’s cash flow with its yield to maturity, multiplies it by the time to cash flow and divides that by the bond’s price.
@everetra - I think that the discussion is largely academic since most individuals won’t be trading mortgage backed maturities. You will probably be including some bonds in your investment portfolio, and if you do, you can use the investment formula for bond maturity to determine your risk on that investment. It will certainly be safer than a mortgage, that’s for sure.
@nony - Yeah, when the economy crashes, foreclosures run rampant and mortgages are, true to their term, “toxic assets.”
Even in a healthy economy I don’t consider them to be good investments. Do you really want to wait 30 years until the investment pays off – or seven or eight, assuming the mortgage lien holder moves into a new house around that time?
The only good thing about mortgages is the way that they compound interest. That’s the bait, I suppose. If you lend someone money for a mortgage, you could make that money several times over if the loan is not closed before maturity.
The article is right when it says that the weighted average remaining maturity tells you nothing about the health of the underlying asset. This is the bitter lesson that so many banks and mortgage giants learned in the mortgage meltdown in the United States.
Mortgage backed securities were traded like commodities. I have never understood why no one saw the warning signs coming. After all, a mortgage is probably the riskiest investment out there in my opinion; it’s just debt, and the debtor is an individual.
I think the thinking was that if you had a bunch of mortgages backing a security, you would spread your risk. Not everyone would default, so the thinking went. Boy, were they wrong.
Post your comments