how the weighted average remaining term wart works
the wart of a portfolio is a helpful metric because it helps investors understand whether the time to maturity of the assets within the portfolio is relatively short or long for instance a mbs whose underlying mortgages are all very near to the end of their terms would have a low overall wart while one with mortgages that have only recently been initiated would have a higher wart depending on their risk tolerances and sources of funding some investors may prefer being exposed to investments with a particular time to maturity to calculate the wart of a portfolio the investor first adds together the outstanding balance of the underlying assets and calculates the size of each asset in relation to that total then the investor would weigh the remaining time to maturity of each asset by using each asset s relative size as a final step they would then add up the weighted times to maturity of each asset to arrive at a wart for the entire portfolio wart is commonly used in the disclosure materials associated with mbs such as those offered by freddie mac in this context wart serves not to compare two securities but to demonstrate the effects of external forces such as prepayment on the wart of the security an investor considering a freddie mac security would consider these wart calculations when comparing it to an alternative investment or when seeking to construct a portfolio containing different warts example of wartto illustrate consider an mbs consisting of four mortgage loans in which loan 1 has 150 000 of remaining principal due in five years loan 2 has 200 000 due in seven years loan 3 has 50 000 due in 10 years and loan 4 has 100 000 due in 20 years the total remaining value of the loans is therefore 500 000 to calculate the wart our next step would be to calculate each mortgage s share of the total remaining value by dividing each mortgage s remaining principal by the 500 000 total we would find that loan 1 represents 30 of the total loan 2 represents 40 loan 3 represents 10 and loan 4 represents 20 we can then calculate the weighted remaining term of each mortgage by multiplying its time to maturity by its share of the 500 000 total in doing so we find the following weighted remaining terms our final step is to simply add these weighted years together to arrive at a wart for the entire portfolio in this case our wart is 1 5 2 8 1 4 9 3 years wart and interest rate riskin general bonds and other fixed income securities with longer maturities have greater price sensitivity to interest rate changes than shorter maturity securities known as the security s duration mbs and abs with larger warts therefore hold bonds that on average will have more interest rate risk than those with smaller warts one way to reduce this type of risk is through laddering bond laddering is an investment strategy that involves purchasing bonds with different maturity dates which means that the dollars in the portfolio are returned to the investor at different points over time a laddering strategy allows the owner to reinvest bond maturity proceeds at current interest rates over time which reduces the risk of reinvesting the entire portfolio when interest rates are low bond laddering helps an income oriented investor maintain a reasonable interest rate on a bond portfolio and these investors use wart to assess the portfolio wart vs walaweighted average remaining term wart and weighted average loan age wala are both used to estimate the credit risk interest rate sensitivity and potential profitability of fixed income portfolios wam tends to be used as a measure for the maturity of pools of mortgage backed securities mbs it measures the amount of time for the securities in a fixed income portfolio to mature weighted in proportion to the dollar amount invested portfolios with higher warts are more sensitive to interest rate changes wala is essentially the inverse of wart the number of months or years until the bond s maturity is multiplied by each percentage and the sum of the subtotals equals the weighted average maturity of the bonds in the portfolio 1