Question

Fill in the blanks. In a pool of identical fixed rate, fully amortizing loans, as the mortgages become more seasoned, the WAM ____________; the WAL ____________; and the WAC ___________.

		Goes up; Goes up; Goes down
		Goes up; Goes up; Stays the same
		Stays the same; Stays the same; Stays the same
		Goes down; Stays the same; Stays the same
		Goes down; Goes down; Stays the same

Answer 1

Answer)

Goes down; Goes down; Stays the same

SOLUTION

Seasoning is the amount of time that has passed or has been covered since a debt security has been issued. More seasoned means more time has been passed and it is approaching maturity.

Why WAM will go down?

As it becomes more seasoned, weighted average maturity in pool of fixed rate fully amortizing loans will reduce since less years are remaining till maturity.

Why WAL will go down?

Weighted average life (WAL) is the average time period that amount of unpaid principal on a pool of loans remains outstanding. It shows how many years it will take to receive amount of the outstanding principal. Example: if the major portion of the repayment of principal is in 5 years, the WAL will be closer to 5 years. This will reduce as the mortgages become more seasoned.

Why WAC will remain the same?

The Weighted Average coupon (WAC) is the average gross interest rate of the underlying mortgages in pool of loans. WAC will stay the same as the bonds become more seasoned since all bonds are identical. The weighted average coupons will be the same for fixed rate , fully amortizing loans.

Reasons for other options being incorrect:

Option a) is incorrect because WAM, WAL will not go up and WAC will not go down based on above mentioned explanations.

Option b) is incorrect because WAM, WAL will not go up based on above mentioned explanations.

Option c) is incorrect because WAM, WAL will not stay the same based on above mentioned explanations.

Option d) is incorrect because WAL will not stay the same based on above mentioned explanations.