It is a way to look at the term of a loan or bond that accounts for principal pay-downs. If a loan is interest only with a full balloon at the end, the average life will equal the maturity. If there is amortization, principal is being paid over the life of the loan, decreasing the balloon payment and the average life. This number is then used to find the treasury that has the closest remaining term, but is not shorter.
Example: a 10/25 loan has an average life of 9 years.
If 9 years from today is October 2021, the current list of outstanding, non-callable US treasury securities with maturities in 2021 includes March 2021, June 2021, September 2021 and a December 2021.
The lender would choose the December 2021 because it is longer than the actual due date.
Posted in: Terms for: A