Weighted Average Life (WAL)
Candlefocus EditorWAL is also a measure of risk. Interest payments do not factor into the WAL calculation; rather, only payments to the principal count towards the total. For example, if payments to the principal are made in five years, WAL will be close to five years. This indicates that the loan carries less credit risk. For this reason, many investors will select the bond with the lower WAL over another.
To calculate WAL, the beginning balance of the loan is taken into account, as well as all payments to the principal from each period. The outstanding principal from each period is also taken into consideration. After the calculations are completed, WAL is determined. It is generally expressed as a percentage of the total remaining principal outstanding at the end of the loan’s life.
Weighted average life is an important tool for loan underwriters, investors, and bondholders. It is a useful tool for understanding the debt of borrowers, estimating cash flow, and managing financial risk. It is also used in asset and portfolio management to ensure the repayment of loans and bonds.
A lower WAL indicates less credit risk and, therefore, a borrower with a lower WAL will generally be viewed as a more viable option for investors. For this reason, it is important to understand the weighted average life of a loan or bond before making an investment. This will help ensure investors and underwriters understand the risk they are taking on and make better investment decisions.