Understanding Weighted Average Life (WAL)
If you're interested in the world of trading, then getting familiar with the term 'Weighted Average Life' or WAL, is essential. The Weighted Average Life is a measure that is commonly used in the bond market. It helps investors to estimate the average time it takes for the principal on a bond to be repaid. The calculation places more weight on the periods when most of the principal is expected to be repaid. Learning how this tool works can be a game changer in your trading strategy.
How is Weighted Average Life calculated?
Weighted Average Life doesn't have to be a complex jigsaw puzzle. It involves straightforward maths. The WAL of a bond is arrived at by multiplying each payment by the time until that payment is made and adding up these times, and then dividing this sum by the total amount of all payments. This calculation takes into account the differing times and amounts of all payments, making it extremely comprehensive and accurate.
Importance of Weighted Average Life in Trading
So, why is it vital to understand Weighted Average Life when trading? The answer lies in its importance in bond investing. Bonds are widely used financial instruments in trading, and a bond’s WAL can significantly impact its returns and your investment strategy. When buying a bond, it’s crucial to anticipate when the borrowed principal will be returned—this is where WAL steps in. Looking at shifts in a bond's WAL is one way of gauging changes in expected principal repayments.
WAL affects Trading decisions
Being versed in Weighted Average Life can make you a more informed trader. Traders often use WAL to align their trading strategies with their investment goals. For instance, bonds with a shorter WAL might be more attractive to investors seeking a quicker return of their initial investment. Conversely, bonds with a longer WAL will likely be more attractive to those seeking investments that provide a more extended, steady return.
