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Mortgage Backed Securities And Their Risks

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As compared to the plain vanilla bonds, the Mortgage-backed securities or the MBS can add new risk from its database of unique features.

  1. The Mortgage-backed securities are affected by the residential mortgages and are thus collateralized.
  2. The monthly payments pass to the investor of the third party from the originating bank.
  3. The amortization is carried over the entire life time. More specifically, the principle amount is sometimes paid off with payment made a month wise. On the other hand, the bond has monthly interest payments as compared to the MVS whose principle is paid at maturity.
  4. The investors are the receivers of unscheduled prepayments assuming pro-rata that are of the principals because of refinancing, foreclosure and house sales. The mortgages are paid off much sooner as compared to a typical mortgage may have a term of 30 years.


Weighted Average Life

Weighted Average Life or WAL is one of the most effective tools to measure effective maturity of the MBS. The WAL is one of the most common methods as well and is also known as the average life.

In order to calculate WAL, the fraction of the year and the month of each payment to be made are multiplied by the percentage of the total principal. This percentage is paid off at that date which is later added up from the results.

Therefore, when WAL is calculated, it basically calculates the pay downs and its impact over the lifetime throughout its life. In a visual scenario, WAL is a fulcrum that stretches between the origination and the final maturity date on the timeline.

It focuses on balancing the principal payment exactly like balancing several children of different weights on a seesaw after acquiring variant positions. Therefore, the main focus is on balancing the principal payments exactly like balancing a number of children of various weights on different positions of a seesaw.


The Mortgage-Backed Securities are traded at premiums discounts or par value that depend upon the changes that occur in the current market. The assumptions arising from the prepayment is thus a highly critical to the mortgage pass-through securities. However, the time and amount are not known, which means that these variables must be identified via projections. Read the full story


September 2011
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