The
interest rate the
holder of a
mortgage-backed security is
paid. It is calculated by taking the
gross of the interest rates
owed on the
mortgages underlying the security and
weighting them according to the percentage of the security that each mortgage represents. For example, if a very simple MBS is backed by three mortgages, one representing the gross interest rate and the other two representing one-quarter each, one gives twice the weight to the first mortgage when calculating the weighted average coupon. It is important to note that the weighted average coupon rate may change over the life of the MBS because different
mortgage holders pay down their mortgages at different rates, changing the weights. See also:
Prepayment risk.