The weighted average life expectancy for a bond or another profitable investment refers to the average period of time for an original dollar to be repaid. Bonds with a higher average life-cycle value may be riskier. Keep in mind that the average life span of the sovereign is generally smaller than the maturity time, which measures how long it takes for a bond to complete the full payment.
Principal Repayment Bonds
While people often think of bonds as an investment that you can buy and sell on the open market similar to stocks, it’s also often helpful to think of bonds as a loan. After all, companies and government agencies issue bonds to borrow money, usually to pay for short-term projects in the long run.
For the duration of the bond’s existence, the bond will return the money according to a set schedule, including principal and interest. Unlike many loans that individuals borrow, bonds may not return fixed amounts over time and may make larger payments at certain times during the bond’s term.
It is often useful for investors to figure out roughly when the principal, or the original loan amount of the bond, will be repaid. Bonds take longer to do that which can be riskier than those that pay their principal faster, taking into account other considerations such as the issuer’s credit rating and the overall economic situation.
The average life is weighted.
The period of time that an average principal dollar of a loan remains is called the sovereign average life span. You can use the permission average depreciation formula during the period to find this value.
To do so, take a look at the bond’s issue documents or other documents to know when and how many bonds pay back during their lifetime. Calculate the total amount of return to find the total amount of bonds returned. Then, for each payback amount, multiply that amount by the future distance and the sum of those numbers. Divide that larger amount by the smaller total payback to have the weighted average life span of the bond.
For example, consider a bond that returns $5,000 in a year, $10,000 for two years, and $20,000 for four years. Its total payback is $35,000. The total weight is $5,0001+$10,0002+$20,000*4=$105,000. Divide $105,000 by $35,000 for a weighted average life expectancy of 3 years. Note that you can use another unit of time, such as months or days, if it’s more convenient, as long as you make sure that all time periods are indicated by the same unit.
Factors affecting the average family life
Bonds that return more money earlier will have a shorter average life cycle. For example, consider the example above, but imagine that the $20,000 payment and the $5,000 payment are interchangeable.
At that time, the average life expectancy was weighted = ($20,000 * 1 + $10,000 * 2 + $5,000 * 4) / $35,000 = $60,000 / $35,000 or about 1.71 years. Because large paybacks come earlier, the average life expectancy is shorter.
Average life expectancy and maturity time weighted
When a bond has repaid everything it will have to pay, it is said to have matured. Maturity dates are often far beyond the average period of entitlement, which makes sense because it takes into account the time the bond is returned interest as well as the principal. The sovereign life expectancy may be a more useful measure of a bond’s payback period than maturity for a variety of purposes.