what is average life 
the average life is the length of time the principal of a debt issue is expected to be outstanding average life does not take into account interest payments but only principal payments made on the loan or security in loans mortgages and bonds the average life is the average period of time before the debt is repaid through amortization or sinking fund payments investors and analysts use the average life calculation to measure the risk associated with amortizing bonds loans and mortgage backed securities the calculation gives investors an idea of how quickly they can expect returns and provides a useful metric for comparing investment options in general most investors will choose to receive their financial returns earlier and will therefore choose the investment with the shorter average life understanding average lifealso called the weighted average maturity and weighted average life the average life is calculated to determine how long it will take to pay the outstanding principal of a debt issue such as a treasury bill t bill or bond while some bonds repay the principal in a lump sum at maturity others repay the principal in installments over the term of the bond in cases where the bond s principal is amortized the average life allows investors to determine how quickly the principal will be repaid the payments received are based on the repayment schedule of the loans backing the particular security such as with mortgage backed securities mbs and asset backed securities abs as borrowers make payments on the associated debt obligations investors are issued payments reflecting a portion of these cumulative interest and principal payments calculating the average life on a bondto calculate the average life multiply the date of each payment expressed as a fraction of years or months by the percentage of total principal that has been paid by that date add the results and divide by the total issue size for example assume an annual paying four year bond has a face value of 200 and principal payments of 80 during the first year 60 for the second year 40 during the third year and 20 for the fourth and final year the average life for this bond would be calculated with the following formula 80 x 1 60 x 2 40 x 3 20 x 4 400then divide the weighted total by the bond face value to get the average life in this example the average life equals 2 years 400 divided by 200 2 this bond would have an average life of two years against its maturity of four years mortgage backed and asset backed securitiesin the case of an mbs or abs the average life represents the average length of time required for the associated borrowers to repay the loan debt an investment in an mbs or abs involves purchasing a small portion of the associated debt that is packaged within the security the risk associated with an mbs or abs centers on whether the borrower associated with the loan will default if the borrower fails to make a payment the investors associated with the security will experience losses in the financial crisis of 2008 a large number of defaults on home loans particularly in the subprime market led to significant losses in the mbs arena 1special considerationswhile certainly not as dire as default risk another risk bond investors face is prepayment risk this occurs when the bond issuer or the borrower in the case of mortgage backed securities pays back the principal earlier than scheduled these prepayments will reduce the average life of the investment because the principal is paid back early the investor will not receive future interest payments on that part of the principal this interest reduction can represent an unexpected challenge for investors of fixed income securities dependent on a reliable stream of income for this reason some bonds with payment risk include prepayment penalties 